Very rarely do borrowers ever ask or even understand how their mortgage payment breaks down each month. People intuitively know that some portion is principal and another is interest. However, they usually don’t know how much is going to principal and how much is going to interest.
The first thing you should know is that interest on mortgages and loans is front loaded. In other words, the early years of your payments are mostly interest. It takes quite a bit of time before you are paying more principal each month than interest. Most of the money the banks make on loans is made early on, not at the end.
Let’s consider a 30 year fixed rate mortgage of $300,000 at 5%. The principal and interest payment would be $1610.46 each month. The very first month, only $360.46 goes towards principal while $1250 goes towards interest! The second month, $361.97 goes towards principal and $1248.50 goes towards interest. Whippee! We are making some progress!
Let’s take a look at it graphically below (click to make it larger). You can clearly see that the the majority of your payment goes towards interest each month instead of principal. However, over time, it begins to shift. In this scenario, it takes more than 194 months or just over 16 years before at least 50% of your monthly payment is going towards principal.
While this amount of time is scary indeed, it is also important to remember that homeowners rarely keep a single mortgage for thirty years. In fact, the last statistic I saw said that 90% of mortgages are paid off (refinanced or home sold) within seven years.
