What Is the Mortgage Balance Called? Explained
Discover the definitive term for your mortgage's outstanding balance and why understanding it is vital for every homeowner.
A mortgage is a significant financial commitment for many people, often representing the largest debt they will undertake. Understanding the terminology associated with a mortgage is important for managing this debt effectively. Knowing the precise amount still owed on your home loan helps in financial planning and decision-making. This knowledge helps track progress towards homeownership and make informed choices.
Understanding the Principal Balance
The term most commonly used to describe the outstanding amount on a mortgage is the “principal balance.” This represents the portion of the original loan amount that you still owe to the lender. It excludes any interest that has not yet accrued or other charges.
At the beginning of a mortgage, the principal balance is equal to the total loan amount. As you make payments, this balance gradually decreases. It is the core debt your monthly payments are working to reduce.
How the Balance Changes Over Time
Mortgages operate on an amortization schedule, where fixed payments gradually pay off the loan over its term. Each monthly mortgage payment is divided, with a portion allocated to cover the interest accrued since the last payment and the remainder applied to reduce the principal balance. Early in the loan’s life, a larger share of each payment goes towards interest because the outstanding principal balance is still high. Over time, as the principal balance decreases with each payment, less interest accrues, and a larger portion of subsequent payments reduces the principal.
Making additional payments towards the principal can accelerate the reduction of your mortgage balance. Even small extra payments can significantly shorten the loan term and reduce the total interest paid. This strategy helps build equity faster and can lead to paying off the mortgage years ahead of schedule.
Distinguishing Related Mortgage Terms
While the principal balance refers to the amount of money still owed on the original loan, other terms are often associated with mortgages and can sometimes be confused with it.
The “payoff amount” is different from the principal balance. It represents the total sum required to close out your mortgage at a specific point in time. This amount includes the current principal balance, any interest that has accrued but not yet been paid, and potentially other fees, such as prepayment penalties. A payoff quote is valid for a limited period, often 10 to 30 days, because interest accrues daily.
The “total loan amount” refers to the original sum borrowed at the mortgage’s inception, before any payments have been made. It serves as the starting point from which the principal balance begins to decrease over the loan term.
An “escrow balance” is held in a separate account. Funds in this account are collected as part of your monthly mortgage payment and are used to pay for recurring property expenses, such as property taxes and homeowners insurance premiums. This balance is distinct from the mortgage principal and does not directly reduce the amount you owe on the loan.
“Home equity” represents the portion of your home’s value. It is calculated by subtracting your outstanding mortgage balance from the current market value of your property. As you pay down your principal balance and as your home’s value increases, your home equity grows.
Why Your Mortgage Balance Matters
Understanding your mortgage balance is important for effective financial management and planning. Tracking this balance allows you to monitor your progress toward owning your home outright, which can be a motivating factor in long-term financial goals. Regularly reviewing your balance helps you visualize the reduction of your debt.
The principal balance is a factor when considering refinancing your mortgage. A lower balance can open up opportunities for more favorable loan terms, such as a lower interest rate or a shorter repayment period, saving money over the loan’s life. When selling a home, knowing the exact principal balance is essential to determine the net proceeds from the sale. The mortgage balance also serves as an indicator of your overall financial standing and contributes to wealth accumulation.