One of the upsides of buying a home as opposed to renting is that each monthly mortgage payment gets you a little closer to fully owning your home sweet home. Rent, on the other hand, just buys you a month's worth of roof over your head. But only a portion of your mortgage payment goes to principal – actually paying back what you owe on the loan. Another portion – a much bigger portion, for much of the loan – is interest.
TL;DR (Too Long; Didn't Read)
Your loan amount, interest rate, loan term and time in repayment all determine how much of your mortgage payment goes to the principal. Early on, much more of your payment goes toward interest.
Principal Versus Interest
A typical fixed-rate mortgage has level payments, meaning that you pay the same amount each month. That payment covers both principal and interest, but the proportion of each changes over time. When you first start repaying the loan, principal makes up only a small part of each payment, while the bulk of the payment is interest. Each month, the principal portion gets a little bigger, while the interest portion gets a little smaller.
If you stay in the home for the full term of the loan – that's 30 years, for most mortgages – your payments at the end will be almost entirely principal, with just a little bit of interest. Adjustable-rate mortgages have level payments, too, but the lender recalculates the payment amount each time it adjusts your rate. That could be once a year, once every two years, or whatever the loan agreement calls for.
Proportion Starting Out
The exact amount of each payment that goes to principal depends on how much you've borrowed, the length of the loan term, the interest rate and how long you've been paying off the loan. Say you borrow $200,000 for 30 years at a fixed rate of 5 percent interest. Your monthly payment will be $1,073.64. Your first payment will include $240.31 toward the principal and $833.33 in interest.
If you'd borrowed that same amount at 8 percent interest, your monthly payment would be $1,467.53, and your first payment would include just $134.20 toward principal and $1,333.33 in interest. You can run numbers for yourself with any loan amount, loan term and rate by using an amortization schedule calculator, available at many financial websites.
Proportion Down the Road
The reason interest makes up such a big chunk of your payments at the start is that you're paying interest on the entire loan amount – the entire principal. As you reduce the principal with each payment, the interest due declines, so you have more "room" in your monthly payment for principal.
It takes time, though – a lot of time. On a 30-year loan at 5 percent interest, you have to make payments for more than 16 years before each payment includes more principal than interest. At 8 percent, it takes more than 21 years.
Adding it All Up
Jump ahead 30 years. You've made all your payments, and you own that $200,000 home free and clear.
At 5 percent interest, you will have made 360 payments of $1,073.64, for a total of just over $386,500. Of that, $200,000 went to principal, and the remaining $186,500 or so was interest. At 8 percent, your total payments would equal about $528,300 – you would have paid $328,300 in interest, far more than the $200,000 you repaid in principal.
The cutoff point is about 5.3 percent. If your rate is higher than that, you'll pay more in interest than principal over 30 years. If it's lower, you'll repay more in principal than interest.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.