How Do Principal Payments Work On A Home Mortgage?

Too many Americans stay in debt longer than necessary simply because they don’t understand the relationship between principal payments and simple interest. Figure out your mortgage options here:

Megan is with us in bakersfield california hi megan how are you i’m doing real better than i deserve how can i help okay so one i just have like a pretty weird personality so i might get all crazy here but we’re on the tail end of baby step two we only have like $3,600 me on the one bill and my husband is finishing the last of his prerequisites to start nursing school

And we plan on just bankrolling that the whole way through with help from parents and we don’t want to take out loans good so i am more of like a future planner like i don’t like to think just like where we’re gonna be in five years like i’m thinking more about the mortgage when my husband graduates because a lot of a much larger income and i have heard a lot about

Like prepaid interest or prepaid principal and they don’t really understand how that works like i was watching the pill method and then he was talking about taking out loans and i was like this guy’s and not listening to it but that’s kind of where i was that was how do principle payments work yeah it makes it sound like there’s some kind of a magic to it it there’s

Nothing magic to it at all you take the interest rate of your mortgage and you multiply it or divide it by 12 okay and you multiply that times the outstanding balance that month that is the interest charged that month does that make sense mm-hmm and the rest of your payment goes towards principle and so let’s just make up some easy numbers let’s say 6% interest

Rate which would be very well issues 3% interest rate okay that’s current that’s a quarter of a percent 0.25 per month if you divide three percent by 12 okay you’ll get a quarter of a percent per month and it and so if you had a hundred thousand dollar loan just to make the numbers real round just because it’s a good it’s a good lesson to walk through you’d say

0.025 is your oops i did that it’s point zero two five still not doing that right a hundred thousand but i put too many things in the calculator one time point oh no two five there we go okay there we go two hundred bucks i should be able to do that in my head alright anyway two hundred fifty dollars of your payment that month if you have a hundred thousand dollar

Balance that three percent would go towards interest right okay now let’s say your payment was three hundred and fifty dollars it wouldn’t be let’s say it’s four hundred and fifty dollars okay okay and then so 250 went to interest the other two hundred dollars would pay the $100,000 does that make sense yeah the next month your interest is calculated on ninety eight

Thousand eight hundred dollars at a quarter and so instead of being two hundred fifty dollars i make up a number let’s say it’s two hundred forty-seven dollars okay but your payment your payment is still four hundred dollars but a little bit less when to interest so a little bit more goes to principle so instead of paying two hundred dollars towards principal the

Next month in our example it might be two hundred and three dollars you follow me okay so if every time you pay principal that makes your next payment more of it go towards principal less towards interest so it’s like say for example i was gifted a thousand dollars for i don’t know just being amazing and somebody and we went and put that on the principal yes would

That change our payment the next month no a mint stays the same it changes the amount of interest would go down because you’re gonna be charged interest on a thousand dollars less you’re not paying interest on that thousand dollars anymore okay and so it would cause your your payment would stay exactly the same but more of your payment would go towards principal

Oh you don’t have as high an interest charge because you don’t have as high a balance your interest is calculated on the balance each month you pay your interest rate only on what’s outstanding so if you throw 10,000 bucks at a mortgage you don’t pay interest the next month on that $10,000 it saves you the interest on that $10,000 your payment stays the same so a

Lot more of your payment would then go towards principal the following month than it did before so that’s why sometimes people say oh you know i don’t i don’t wanna i’ve already paid all the interest so i don’t want to pay my mortgage off because i don’t have already paid all the interest upfront no you didn’t you only pay interest on what’s outstanding and once

You’ve paid on the mortgage for years and years and years and you paid the principal down your payment is still the same much much more of your payment goes towards principal after 15 years and a 30-year mortgage then at the 28th year of a 30-year mortgage exactly okay yeah this is the kind of stuff that they should teach in high school because nobody taught me

That yeah that’s exactly right well good news is 36 percent of the high schools in america now carry a dave ramsey high school curriculum called foundations and personal finance so we’ve got a little over a third of them but we got the other 2/3 to go so but you’re exactly right that’s called a simple interest calculation that i just walked through with you but

That’s how any mortgage is calculated have you ever seen the tables printed out on a mortgage payment where it shows the columns and shows your payment it shows how much it’s going to interest how much it’s going to principal and who you slide your finger down your down the page you’re like wow a whole lot more after paying you know 120 payments paying 10 years

A whole lot more of its going towards principal and an interest you follow me yeah if you’ve ever seen that so what happens is if you want to do this easy without having to do the raw math if you pay $10,000 on your balance you just slide your finger down the outstanding balance and your own payment number 37 when you did it then you pay $10,000 then you’re gonna

Drop down it might be looking more like payment number 61 there’s gonna be your next payment so you’re just knocking out chunks of payments it’s gonna be calculated like payments 61 whatever wherever the balance is closest to the new balance after you paid your 10,000 bucks down so it’s an item that really helps a lot i was super worried about it because i really

Want to get it paid off within like 10 years after he graduates yeah that’s why throwing money at the mortgage early and often when you get to baby step 6 is so important if you but it’s also why you don’t need to do more than once a month because they only recalculate once a month the payments are monthly payments and so if you send for payments in a month it

Doesn’t change the math at all now they all go towards principal but you might as well just send one check and so i’ve seen these groups with these supposed systems that they’ve gotten all this bs where you just start sending payments and you don’t want it you want to send one a week and now it doesn’t work because the calculation is done once a month it is 1/12

Of the interest the annual interest rate per month it is not a daily or a weekly calculation on mortgages now some credit cards are calculated daily and some are calculated twice or three times or four times a month so they’re a little different but anything that’s calculated once a month paying on it more than once a month does not change the math do you understand

Yeah cool it’s good to talk to you thank you for calling you that’s a good question

Transcribed from video
How Do Principal Payments Work On A Home Mortgage? By The Ramsey Show – Highlights