A Principal and Interest Calculator for Monthly Loan Payments
A mortgage, student loan or other debt typically requires the borrower to make monthly payments to the lender that consists of interest and principal. The interest rate is what the lender is charging you for borrowing the money. The interest rate on a mortgage or a student loan is usually much lower than the interest rates paid on credit card debt. Each month, a piece of the payment covers the interest and the rest is applied to the principal. The calculator we provide (below) is designed to help you understand how much of your payment is applied to each and calculate your “balance forward” after you make the payment.
What is the Principal on a Loan?
The principal is simply the unpaid balance on your loan. While the principal will change according to the amortization process specified in your loan, it is usually reduced at an increasing rate as your loan matures. In a situation where a principal balance actually increases with each loan payment you make, it is referred to as negative amortization. With negative amortization, the borrower makes monthly payments that do not cover the interest. At the end of the month, this unpaid interest is added to the balance of the loan, causing it to increase.
Side Note: Negative Amortization and the Current Mortgage Crisis
Aggressive mortgage loan programs that lead to negative amortization have played a significant role in the current mortgage crisis. As home prices increased, lenders felt they had to develop creative financing options to attract buyers. By lowering monthly mortgage payments with programs that led to negative amortization, borrowers actually paid less than the rate on the loan, thus increasing the balance of the loan every month.
Why Paying Down Your Principal Can Make Good Financial Sense
With a debt, like a mortgage, that requires monthly payments, these payments are amortized. As we’ve already noted, this means a portion of each payment goes toward interest and a portion toward paying down the remaining loan balance. Any extra payment you make towards principal decreases the amount of interest you will pay in the future. As a example, if you pay $1,000 toward your mortgage that carries an interest rate of 6%, you save $60 of interest each year for the rest of the mortgage term. This is equivalent to earning an after-tax return of 6% every year on that extra payment.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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