What Is Principal and Interest (P&I) on a Mortgage?

When making a mortgage payment, a portion of the funds goes towards Principal and Interest (P&I). This fundamental part of a monthly mortgage payment covers the cost of borrowing money and gradually reducing the loan balance. Understanding these two components helps homeowners manage their mortgage and comprehend where their money is allocated each month.

Components of P&I

The principal in a mortgage represents the actual amount of money borrowed from the lender to purchase a home. For example, if a home costs $300,000 and the buyer makes a $60,000 down payment, the principal amount borrowed would be $240,000. Each payment made towards the principal directly reduces the outstanding loan balance, which in turn increases the homeowner’s equity in the property.

Interest is the cost charged by the lender for borrowing the money. It is expressed as an annual percentage rate (APR) and is calculated on the remaining principal balance of the loan. Factors influencing the amount of interest paid include the initial loan amount, the interest rate, and the overall term of the loan, such as a 15-year or 30-year period.

How Principal and Interest Interact

For most fixed-rate mortgages, the combined Principal and Interest payment remains constant throughout the loan term. However, the distribution of this payment between principal and interest changes significantly over time. This process is known as amortization, which is the gradual repayment of a debt through regular, scheduled payments. An amortization schedule details how much of each monthly payment is allocated to principal and interest.

In the initial years of a mortgage, a larger portion of each monthly payment is directed towards paying off the interest accrued on the outstanding balance. As the loan matures and the principal balance decreases with each payment, a greater share of the fixed monthly payment then goes towards reducing the principal. This shift means that in the later stages of the loan, more of the payment contributes to building home equity. For instance, in an early payment, $800 might be interest and $700 principal, but this ratio flips over the loan’s life.

P&I Within Your Full Mortgage Payment

While principal and interest constitute a significant part of a mortgage payment, they are not the only components. Homeowners encounter the acronym PITI, which stands for Principal, Interest, Taxes, and Insurance, representing the full scope of their monthly housing costs.

Property taxes are levied by local government authorities and are collected by the mortgage lender as part of the monthly payment. These funds are held in an escrow account and then disbursed by the lender to the appropriate tax authorities when due. This arrangement ensures that property taxes are paid on time, reducing the risk of a lien on the property.

Insurance refers to homeowner’s insurance, which protects the physical structure of the home and its contents against various perils, and Private Mortgage Insurance (PMI). PMI is required if the down payment is less than 20% of the home’s purchase price, and it protects the lender in case the borrower defaults. Like property taxes, these insurance premiums are collected by the lender and held in an escrow account, ensuring timely payment. Lenders require an escrow account as a condition of the loan to ensure these ongoing obligations are met.