Understanding what the Loan Principal is

BY The Lenders Network

3 minute read

Your monthly mortgage payment is split up and goes towards different items.

Your escrow account, interest, and the loan principal.

Let’s take a deeper look into what the loan principal is.

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Loan Principal Definition

Loan principal is the balance of a loan. When you make your monthly payment it’s applied to the interest first, if you have an escrow account it is funded second, and the remaining amount is applied towards the principal balance of the loan.

Each mortgage payment you make will reduce the principal balance meaning more of your payment will be applied to the loan balance.

When you extra principal payments or make monthly payments for more than the amount due that money is applied towards the balance.

For example: If your monthly mortgage payment is $1,500 and you send the mortgage company a check for $1,700. The additional $200 is applied towards the principal balance.

Loan-to-Value Ratio

You need to know your loan principal to calculate your loan-to-value ratio (LTV ratio). The LTV ratio is calculated by dividing the balance of the loan by the apprised value of the property.

For example: If the principal balance of your loan is $100,000 and your home appraises for $200,000 the LTV ratio is 50%. This means you have a 50% equity stake in your home.

How Much of Your Payment Goes Towards the Loan Principal

When you first get a mortgage the majority of your monthly payment is applied towards interest. Each payment lowers your principle balance and more of your mortgage payment will go towards the loan balance.

To find out exactly how much of your payment goes to the loan principal you can us a loan amortization calculator.

A mortgage is an amortized loan that has an amortization schedule detailing the amount of the payment that goes towards the principal and interest each month. A borrower can pay extra towards your loan principal to pay off your mortgage loan quicker and reduce the amount of interest you pay over the life of the loan.

Factors that Affect Your Interest Rate

The lower interest rate you have means more of your payment goes towards the balance on the loan. Interest rates are usually determined by your credit score. The higher your score the lower interest rate a lender will offer you.

The loan term will also affect the amount of your payment that is applied to the principal. A 15 year fixed-rate mortgage will have a lower mortgage rate but the monthly payment will also be higher so the principal is paid off much quicker.

An adjustable-rate mortgage starts off with an initial low interest rate for a fixed period of time. After a set number of years that rate will increase on an annual basis. More of your payment is applied towards principle at the beginning and increases as the loan ages.

Interest-only loans do not have a principal payment, the entire amount is applied towards interest. If you have an interest-only loan you should speak to your loan servicer or another lender about refinancing your loan.

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