What Is P&I - Principal and Interest - And How Can I Save on My Mortgage?

You found a home, secured a loan, and are diligently making payments on your American dream. But just where are those payments going every month? And is there a way to pay extra to lower a mortgage payment? To answer those questions and more, let’s talk about principal and interest.

What is mortgage P&I?

In the mortgage world, P&I (principal and interest) means the payment required to repay a home loan in accordance with its terms. Together, P&I makes up the majority of your monthly mortgage payments early in the loan term.

What is principal?

Principal is the amount you borrow for a mortgage and have to pay back. For example, if you buy a home for $300,000 with a 20 percent down payment ($60,000), your loan principal is $240,000.

What is interest?

On top of the principal, a loan is paid back with interest. Interest is the additional amount owed to a lender for the ability to borrow money. The amount of interest you pay is based on a percentage of the principal, which is the interest rate. The higher your interest rate, the more you’ll end up paying in total. Interest rates may be fixed (the same for the term of the loan or until you refinance) or adjustable (changing with market interest rates and other factors).

Continuing with the example above, if your interest rate is 5 percent, a $240,000 loan principal adds $12,000 in interest for the first year of your loan (.05 x $240,000). As you pay down your mortgage, reducing the principal, the amount you pay in interest also decreases.

What affects my P&I payment?

Your mortgage P&I payment is based on three factors:

1. Principal – How much money you borrow
2. Interest rate – What a lender charges you to borrow money, expressed as a percentage of the principal
3. Loan term – How long you have the loan

Your lender will use an amortization formula to calculate your payment. Amortization simply means the process of paying off debt with a known repayment term in regular installments over time.

Fortunately, you don’t have to be an accountant to understand how amortization works. Here’s how each element can affect your P&I payment.

The calculation will result in a consistent P&I payment that you’ll pay monthly. Although the total amount will be the same, the amount you pay toward principal and interest will change throughout the life of the loan. If you have an adjustable-rate mortgage, the payment will be recalculated with every interest rate change.

Amortization example:

A helpful way to visualize P&I payments is through an amortization schedule. Let’s use our same example with the following inputs:

• Principal – $240,000
• Interest rate – 5% (fixed rate)
• Loan term – 30 years (360 months)

As you can see, the P&I payment remains consistent throughout the life of the loan at $1,288.77. The first few payments have most of that payment going toward interest, while under $300 goes toward principal each month.

Fast forward to month 195, and the pendulum starts to swing the other way: Just over half of the payment ($646.07) now goes toward the principal. When we finally reach payment 360, only $5.35 is allocated toward interest, while the remaining balance of $1,283.03 is paid off.

To see your payments in action, ask your lender for a full amortization schedule for your loan.

How to lower your mortgage payment

Gaining a clear idea of your P&I payment can motivate you to seek ways to lower your mortgage payment– reducing monthly costs, or what you’ll pay in the long term. Here are some ways to help move the needle.

Pay additional on the principal

Have extra cash piling up? You may consider putting it to use to pay down your mortgage principal. Paying additional on the principal can help you pay off your mortgage faster and lower the amount you pay in interest.

Extra principal payments can be made in a lump sum or in small, regular increments – whatever works best for you. Some people schedule automatic biweekly or monthly payments, while others make one or two extra mortgage payments a year. You can even use a combination of methods.

The key is to specify that the payment should go toward the principal and not interest. You should be given this option whether you’re making a payment online or working directly with your lender.

Refinance to an ARM or a lower fixed rate

As we discussed, a lower interest rate can lead to a lower payment. If you think you’re out of luck because you’re locked into a fixed rate mortgage, think again. You may be able to reduce your interest rate through a mortgage refinance.

If rates have dropped since your initial mortgage, it could be possible to lock in a lower fixed rate. If that’s not the case, there’s still hope through an adjustable rate mortgage (ARM). ARMs start with an introductory period that typically offer below-average rates. Before refinancing, it’s important to understand how ARMs work and how you can maximize their benefits.

Refinance to a shorter term

A shorter term will increase your monthly payment, but it can lead to significant savings over the life of the loan. It’s generally only recommended to refinance to a shorter term if you can secure a lower rate in the process. Otherwise, you can simply make additional payments on the principal to achieve the shorter term without paying refinance closing costs.