Borrowing
Learn how mortgages work, what affects your principal-and-interest payment, and why the interest rate and loan term can change the cost of financing a home.
A mortgage is a type of loan commonly used to finance the purchase of a home or other real estate.
The borrower repays the loan over a set period of time through scheduled payments. These payments generally include both principal and interest.
The property serves as collateral for the loan. If the borrower does not repay the mortgage as agreed, the lender may be able to foreclose on the property.
When you buy a home with a mortgage, you typically pay part of the purchase price upfront as a down payment and borrow the remaining amount from a lender.
You then repay the loan through scheduled monthly payments over a set loan term. For a typical fixed-rate mortgage, part of each principal-and-interest payment reduces the loan balance, while another part pays interest.
Over time, the balance generally decreases as payments are made. The interest rate, amount borrowed, and loan term all affect the monthly principal-and-interest payment and the total interest paid over the life of the loan.
Key terms
The purchase price of the home.
Money paid upfront toward the home purchase. A larger down payment generally reduces the amount that needs to be borrowed.
The amount borrowed from the lender to finance the home.
The rate used to calculate interest on the mortgage balance.
The scheduled length of the mortgage, commonly expressed in years.
The portion of the monthly mortgage payment used to repay principal and interest.
A mortgage calculator may show the principal-and-interest payment required to repay the loan, but homeowners can have additional housing costs.
Depending on the loan and property, these may include property taxes, homeowners insurance, mortgage insurance, homeowners association fees, and other expenses.
For this lesson, we focus on principal and interest so you can clearly see how the loan itself works.
For a typical fixed-rate mortgage with equal monthly principal-and-interest payments, the payment can be estimated using an amortizing loan formula:
The estimated monthly principal-and-interest payment.
The amount borrowed through the mortgage.
The annual interest rate converted to a monthly rate.
The total number of scheduled monthly payments.
The formula shows why the amount borrowed, interest rate, and loan term can all affect the monthly principal-and-interest payment.
Try it yourself
Keep the home price and down payment fixed, then change the interest rate or loan term to see how they affect the mortgage.
This is a simplified educational estimate based on a fixed loan amount and fixed interest rate. The results show principal and interest only. Property taxes, homeowners insurance, mortgage insurance, homeowners association fees, and other costs are not included.
What changed and why?
Change the interest rate or loan term in the example above to see how each one affects the mortgage. A higher interest rate generally increases borrowing costs, while a longer loan term can reduce the monthly principal-and-interest payment but increase the total interest paid.
Compare loan terms
For the same loan amount and interest rate, the loan term changes both the monthly principal-and-interest payment and the total interest paid over time.
The loan is repaid over fewer years, so the monthly principal-and-interest payment is generally higher.
However, the loan is repaid faster and generally results in less total interest.
Repayment is spread across more years, so the monthly principal-and-interest payment is generally lower.
However, the longer repayment period generally results in more total interest.
Key takeaway
A mortgage allows you to finance a home and repay the amount borrowed over time. The loan amount, interest rate, and loan term all affect the principal-and-interest payment and the total cost of borrowing.
A longer loan term can reduce the monthly principal-and-interest payment, but it can also increase the total interest paid. Remember that principal and interest may be only part of the total monthly cost of owning a home.
Continue learning
Continue learning how loans, repayment, and borrowing costs work.