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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What is the Loan Principal?
The loan principal, or principal balance, is the total amount a borrower owes to the lender 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 loan’s principal balance.
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.
You need to know your loan principal to calculate your loan-to-value ratio (LTV ratio). The LTV ratio is calculated by dividing the principal balance by the appraised 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.
Loan Principal vs. Interest
Your monthly mortgage payment is made of principal and interest. When you first get a mortgage the majority of your payment goes towards interest, the remaining amount goes towards the loan principal.
A mortgage is an amortized loan with 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.
When Your Principal Balance is Higher than Your Home is Worth
If the housing market that’s a hit then your home may be worth less than what you owe on it.
When your home is worth less than the principal balance you’re considered underwater. Luckily, there are programs to help borrowers who are underwater on their mortgage 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. Your credit score usually determines interest rates. The higher your score, the lower the 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 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.