What Does It Mean to Make a Principal-Only Payment?

By Realty Times Published Nov 19, 2024 10:41 am

You’ll hear the terms principal and interest when you get a home loan. Your principal is the amount you borrow for your home loan, and your interest is what you pay monthly to use the loan.

To calculate the principal of a mortgage, you would subtract your down payment from the final sales price of the home you’re buying. The principal you borrow starts accumulating interest right when you take it out.

Your interest payment is the second part of a monthly mortgage payment. You’re paying your mortgage lender to give you a loan, which is reflected in your interest. Most lenders will calculate your mortgage rate in terms of an annual percentage rate or APR. APR is what you pay on your loan per year in interest. If you borrow $200,000 and your APR is 5%, you’re paying $10,000 a year in interest.

Your principal is high at the start of your loan, so during this time, your monthly payment is primarily going towards paying your interest.

A few percentage points of interest significantly affect how much you ultimately pay for your loan. If, for example, you borrowed $150,000 and your interest rate on a 30-year loan was 4%, your monthly payment would be around $716. If you had the same loan but a 6% interest rate, your monthly payment jumps to more than $899.

A difference of just 2% in interest rates, for example, can make a difference of tens of thousands of dollars in how much you pay in interest over the life of your loan.

When you make a payment on your loan, your lender will apply part of your payment to interest and fees before reducing the principal. The lender will use the same formula to pay the interest if you make additional monthly payments. The lender adds up interest accrued during the month, using a part of your payment to pay accrued interest before it’s then applied to your principal.

So, What is a Principal-Only Payment?

A principal-only payment is going entirely toward reducing your principal. Since the amount of interest you pay is based on the principal, your interest charges are smaller when you reduce your principal.

You can pay off debt faster with principal-only payments and save on interest.

Not all lenders will allow a principal-only payment, and some lenders will let you make additional payments during the month, but you need to specify it should go toward only the principal.

Regarding a home loan, you’re making an additional principal payment that’s supplementary and applied directly to your principal mortgage amount, which goes beyond your scheduled monthly payment.

Your monthly payments stay the same, no matter how many principal-only payments you make. You will save more money in interest throughout your loan life.

You might want to recast your mortgage if you want lower monthly payments.

Mortgage Recasting

Finally, if you want to save on your home loan, mortgage recasting can help you pay less interest costs and maybe cut down on the total number of payments you must make before you pay your mortgage in full.

You make a lump-sum payment towards your loan’s principal balance with a mortgage recast. Your lender amortizes your mortgage, reflecting your lower balance. You can lower your monthly payments because your principal went down, but your term and interest rates stay the same.

One example of when someone might recast a mortgage is if they bought a new home before selling their old one. Then, once they sell their previous home, they can use that money to recast their new mortgage.

If you get a bonus or windfall of money for some reason, you might also want to do a mortgage recast. Many lenders will charge a servicing fee for this, but not usually more than a few hundred dollars.

Not every lender will offer this option, and some types of loans aren’t eligible.

You can’t have a government-backed loan and it must meet minimum standards for principal reduction. For example, you usually have to make a minimum payment of $5,000. You’ll also probably need to meet equity requirements, and you have to meet requirements set by your lender for your payment history.