Mortgage Principal Balance: Understanding the Basics
Buying a home is one of the significant financial decisions that you can make in life. But, for most people, it’s impossible to pay for a house upfront. That’s where mortgages come in handy. A mortgage is simply a loan that enables you to purchase a house and pay back the money over time.
When you take out a mortgage, there are several terms and concepts that you need to understand. One of these is the mortgage principal balance. In this post, we’ll explain what this term means and how it affects your homeownership journey.
What Is Mortgage Principal Balance?
The principal balance refers to the original amount borrowed from a lender when taking out a mortgage loan. It includes all of the funds lent by the bank or any other financial institution at closing minus any payments made towards reducing such debt since then.
In simpler terms, if you took out a $200000 30-year fixed-rate mortgage with an interest rate of 3%, your initial principal balance would be $200000, which is also referred to as “the loan amount.” As time passes by and you continue making monthly payments on your mortgage loan, your principal balance decreases until it reaches zero once paid off entirely.
Understanding How Mortgage Principal Works
When calculating your monthly mortgage payment amount, there are four fundamental factors involved:
1. The principal
2. Interest rate
3. Term length
4. Property taxes (if included).
The larger your initial principal balance or loan size is, the higher your monthly payment will be over time since more money needs repaid each month based on rates set by lenders at closing; conversely smaller loans require less overall repayment but may carry higher interest rates due to their riskier nature than larger ones.
For example:
If person A has taken out $100k worth of mortgages with an average interest rate of 5% per year amortized over thirty years, their monthly payments would come out to be $536.82 with property taxes and insurance included. Meanwhile, person B took out the same amount of money but at 3% interest rates over the same period resulting in a monthly payment of $421.60.
Keep in mind that if you make extra payments towards your mortgage principal balance, it can help reduce the overall loan term as well as interest paid over time.
How Your Mortgage Payments Are Applied
Each month when you make your mortgage payment, it gets applied to different parts of your loan balance. The first part is usually applied towards interest while the rest goes towards paying down your principal balance.
For example:
If you have a $200000 mortgage with an interest rate of 3%, and you pay $1000 per month on it for thirty years, then during the first year after closing costs are paid off; about $500 will go straight into interest fees leaving only ~$500 left available to apply reducing your outstanding debt.
The following year though, since more money becomes available from each prior month’s payment going towards reducing owed amounts (plus any potential additional extra payments made), there will be some reduction seen even if just by a few dollars until eventually reaching zero upon full payoff completion date.
Why It’s Important To Keep Track Of Principal Balance
As mentioned earlier, making extra payments toward reducing mortgage principal balances can help shorten overall repayment periods & lower overall interest charges due within future years ahead – something especially beneficial for those looking forward planning retirement goals or other long-term investments accordingly.
Another reason why keeping track of principal balances is important is because it affects how much equity or ownership value one holds in their home at any given time. As homeowners continue paying down their mortgages over time through regular amortization schedules or lump sum prepayments made periodically such as bi-weekly plans some lenders offer–they earn more equity stake percentage-wise in the property they purchased initially.
How to Reduce your Mortgage Principal Balance
There are several ways you can reduce your mortgage principal balance:
1. Pay extra towards the principal: You can make additional payments on top of your regular monthly payments, which will go directly towards paying down the mortgage principal.
2. Refinance: If interest rates are lower than what you’re currently paying, refinancing may be an excellent option to consider since it allows borrowers to replace existing loans with new ones that come at more favorable terms such as lower interest rates – potentially saving thousands annually off future costs due from reduced interest charges over time.
3. Bi-weekly payment plans: Some lenders offer bi-weekly or accelerated payment plans where instead of making one full payment each month, borrowers break their payments into two per month- effectively trickling in extra money toward principle balances paid down faster and reducing overall owed debts’ timeline.
Conclusion
In conclusion, understanding what a mortgage principal balance is and how it works is essential for any homeowner who wants to save money on their loan term length and overall expenses associated with owning property in today’s economy. By knowing the basics behind this concept, borrowers can take steps like prepaying amounts periodically (either lump sum or through other means) or re-financing when needed so they aren’t caught off guard by unexpected costs & fees unexpectedly affecting cash flows later on down the line!