Understanding your principal balances and payments can often be a daunting and confusing task to try to tackle. If you don’t work with numbers often or within a finance company, you may be left wondering why your principal balance on your home loan remains so high, even after making your regular monthly payments.
Your principal balance will indeed decrease each month; however, it may not be as drastic as you expected. In the beginning of your home loan, you will end up paying the highest amount of interest. As your loan matures your principal payments will start to increase and the interest amounts will start to decrease until ultimately, you end up paying more principal than interest.
Related: How to Boost Your Credit Score
You pay interest on the amount of your loan that is still outstanding. For example, if your home loan is $400,000 at a 3% interest rate, your annual interest rate for your first year would be $12,000 ($400,000 x 3%) meaning that $1,000 of each mortgage payment would be going directly toward interest. As you start to pay down your principal balance little by little, your interest amounts will decrease. For example, if you have the same loan above at a principal balance of $395,000, at the same 3% interest rate, your annual interest would now only be $11,850 instead of the previous $12,000, thus, allowing more of your monthly payment to go toward principal. In this example, you would have an additional $150 annually going to your principal balance instead of interest.
The amount of interest you will pay will be in direct correlation with the amount you still owe on the loan. Because of this, if you are hoping to save more on interest and pay down your loan faster, overpaying on your home loan may help save you tremendously in the long run. Not only will you be saving on your interest amounts by lowering the balance of your loan, but you will also be building equity by overpaying on your principal balance and decreasing your balance amount. You can use this equity to your advantage in a number of different ways ranging from selling to a re finance.
Your interest is often reestablished each month, or in some cases annually as shown in the example above, so ensuring you understand which way your interest is calculated will help you understand where your monthly mortgage payments are going, as well as when your principal balance will start to reflect larger payments.
Related: What are my Assets?
Not all lenders are the same and so it is important to look at the terms of your home loan to ensure there are no over payment or early pay off fees associated with your home loan prior to beginning any possible over payments.