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.

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