If you’re a first-time home buyer, it’s important to make sure you understand all terms of the loan so you know exactly what you’re signing up for. Two of these terms, principal and interest, are ones you’ll want to be familiar with, as they can both have a significant impact on how much your monthly payment will be for your mortgage.
So, what exactly do “principal” and “interest” mean when referring to a home loan?
What Is the Principal?
The principal of a loan is the amount of money you borrowed. If the home you buy is $250,000, and you put $20,000 down and borrowed $230,000, then the mortgage principal is $230,000.
When you look at your monthly mortgage statement, the principal will be how much money you have left to pay off before the house is yours. The more money you can put down on the principal, the faster you can pay off the mortgage. This is known as “paying down the principal”.
Many homeowners will pay above the minimum required payment to pay the principal off faster, which is especially beneficial if they didn’t put enough money down initially and are still paying private mortgage insurance (PMI).
What Is the Interest?
Interest is an extra sum of money you pay on a loan. As a homebuyer, you must pay a certain amount as a price for borrowing the money, since the lender is making an investment by lending the money to you. The interest amount comes in the form of a percentage, which is calculated based on the total amount of the home loan.
Your mortgage interest rate can either be fixed or variable. A fixed interest rate means that the rate doesn’t change over the life of the loan. On the other hand, a variable interest rate will fluctuate over time based on a benchmark determined by current market rates.
What Is the Difference Between Principal and Interest?
Every month, when you pay your mortgage, you pay a specific amount. This lump sum of money is split up and put into several buckets.
The two main buckets your payment is split between are principal and interest. The difference between principal and interest is that principal is how much money you have left on the loan, versus interest is money paid to the lender so you can borrow the money in the first place.
Will My Principal or Interest Change?
There are a few instances where the principal balance or interest rate on your home loan may change. These may include the following:
- Paying Down Your Principal: If you decide to pay down your principal by making extra payments, your monthly minimum mortgage payment may change. Interest is then calculated on the amount of principal you owe, so when the principal balance decreases, so does your interest rate.
- Refinancing Your Home: When you refinance your home, you are basically replacing your current loan with a new one. Typically, homeowners look to refinance if they’re trying to get a lower interest rate. Refinancing your home can also decrease the principal balance on your mortgage.
- Choosing an Adjustable-Rate Mortgage: An adjustable-rate mortgage is a home loan with a variable interest rate. In this instance, your interest rate will change along with market rates. This means you’ll enjoy a very low interest rate in good years. However, your interest rate is also at risk of increasing during years when the market isn’t as great.
- Changing Property Taxes or Home Insurance Rates: Property taxes and home insurance policy costs are typically baked into monthly mortgage payments. If either of these change, your monthly payments may change as well.
What Else Is Included In My Mortgage Payment?
Besides the principal amount and interest, other expenses may include Private Mortgage Insurance (PMI), home insurance, and property taxes. The amounts of these expenses will vary based on a number of factors. For example, PMI rates depend on your down payment amount and credit score, while home insurance and property taxes are based on the level of insurance you need and your home’s location.
Are you ready to buy a new home? First Fidelis is a local mortgage lender in Kansas City, offering a wide range of loan products and services. Our speedy loan approval process is great for first-time homebuyers, and we are here to answer any questions you may have.
Fill out our pre-approval application to get started, or contact us today to learn more.