Why does the majority of my mortgage payment start out as interest and gradually move toward mostly principal?

By Jared Coulson AAA
A:

When you make a mortgage payment, the amount paid is a combination of an interest charge and principal repayment. Over the life of the mortgage, the portions of interest to principal will change.

At first, your payment will be primarily interest, with a small amount of principal included. As the mortgage matures, the principal portion of the payment will increase and the interest portion will decrease. This is due to the interest charge being calculated off the present outstanding balance of the mortgage, which decreases as more principal is repaid. The smaller the mortgage principal, the less interest is charged. (If you have negative amortization and your mortgage is actually growing in debt, see Understanding the Mortgage Payment Structure.)

For example, let's examine a simple mortgage for $100,000 at an interest rate of 4% annually and a time to maturity of 24 years. The yearly mortgage payment is $6,558.68. The first payment will consist of an interest charge of $4,000 ($100,000 x 4%) and a principal repayment of $2558.68 ($6,558.68 - $4,000). The outstanding mortgage balance after this payment is $97,441.32 ($100,000 - $2,558.68). The next payment is equal to the first, $6558.68, but will now have a different proportion of interest to principal. The interest charge for the second payment equals $3,897.65 ($97,441.32 x 4%), while the principal prepayment is $2,661.03 ($6,558.68 - $3,897.65).

The principal portion of the second payment is about $100 larger than the first. This occurs because you've paid money towards the principal amount - lessening it - and the new interest payment is calculated on the lower principal amount. Near the end of the mortgage, the payments will be primarily principal repayments.

To learn how to start paying down your principal more quickly, see Be Mortgage-Free Faster.

RELATED FAQS

  1. Where are home values falling the fastest in the US, and why?

    Learn about the metropolitan areas in the United States experiencing the largest drops in median single family homes values ...
  2. How did the ABX index behave during the 2008 subprime mortgage crisis?

    Read about the disastrous performance of the various ABX indexes in the subprime mortgage crisis of 2008 during the middle ...
  3. How do traders use the ABX index?

    Learn about some of the ways traders, banks and even hedge funds have traditionally used the ABX indices to make bets on ...
  4. Why is APR used to compare long-term loans?

    See what benefits an annual percentage rate, or APR, offers to consumers that other interest rate calculations might not, ...
RELATED TERMS
  1. Total Annual Loan Cost (TALC)

    The projected total cost that a reverse mortgage holder should ...
  2. Forbearance

    A temporary postponement of mortgage payments.
  3. Mortgage Modification

    A permanent change in a homeowner's home loan terms that makes ...
  4. USDA Non-Streamlined Refinancing

    A mortgage-refinancing option offered by the United States Department ...
  5. No-Appraisal Mortgage

    A type of home loan used for refinancing for which the lender ...
  6. No-Appraisal Refinancing

    A type of mortgage for which the lender does not require an independent, ...

You May Also Like

Related Articles
  1. FHA mortgages offer flexibility and low down payments, though they're often pricier than traditional loans backed by private mortgage insurance.
    Credit & Loans

    Before You Choose An FHA Mortgage: 7 ...

  2. FHA loans are often a good alternative for those who have trouble obtaining a conventional mortgage, although you do have to pay an insurance premium.
    Home & Auto

    Mortgage For A Manufactured Home? Try ...

  3. You're probably moving a lot and still paying off your student loans. Is it crazy to get a mortgage in your 20s? Here's how to decide.
    Credit & Loans

    Does A Mortgage Make Sense If You're ...

  4. The credit crunch and recession caused financial fear, so it's no great shock that our borrowing habits have changed from less than a decade ago.
    Credit & Loans

    How Our Borrowing Habits Have Changed ...

  5. An article explaining the reader when it makes sense to buy home with cash vs taking a mortgage loan. Most time people would think that having the money to purchase the house is better than a mortgage loan but is it always the case?
    Credit & Loans

    Buying A Home: Cash Vs. Mortgage

Trading Center