What happens to your mortgage payment?

Learn how to calculate how much interest and principal is paid each month

Most mortgage loans include principal, interest, taxes and insurance (PITI), and may also include mortgage insurance. See the PITI page for more information about what each of these are.

If you haven’t already, read about how mortgage payments are calculated. This helps you understand terms mentioned on this page.

When you make a mortgage payment, part of the payment goes to interest and part goes to principal. The interest is the money the lender charges you for lending you the money. The principal is the amount you borrowed. You may have noticed on your monthly statement how much interest and principal you paid last month. It will also show your taxes and insurance paid, and your escrow balance, if those are part of your loan payment.

A mortgage is a simple interest loan. Every time you make a loan payment the following happens.

1. If your payment includes taxes and insurance, those are deducted from the total payment and credited to your escrow account.
2. If you pay mortgage insurance, that payment is deducted from the payment.
3. Your current loan balance is then multiplied by your interest rate per pay period. The result is the interest you will pay for the current month, which is deducted from your payment.
4. The rest of your payment is your "principal" which is subtracted from your current loan balance.

Here is an example of how this works.

John currently owes $187,529.23 on his loan (his current balance). His payment of $1,100.00 just arrived at the lender. His annual interest rate is 2.5%. His lender does the following with the payment.

1. The lender deducts $171.47 from his payment and puts in his escrow account for taxes and insurance. The principal & interest payment is $928.53.
2. The current balance owed ($187,529.23) is multiplied by the interest per pay period (.00208333). The result is $390.69. That is the interest paid this month.
3. The interest paid ($390.63) is deducted from his payment ($928.53). The rest of the payment is $537.84.
4. The $537.84 (the principal) is deducted from his current balance and his new balance is $186,991.39.

The interest paid every month is taken by the lender. This is how the lender makes money. Every month the process is repeated. Eventually John will amortize (pay off) his loan which terminates his mortgage.

Note that interest paid depends on the current loan balance. The balance drops each month because the payment is applied to the balance. Therefore interest also drops every month.