I often hear people express with dismay that 90% of their mortgage payment goes toward interest and that they're not building much equity, especially at the beginning of their loan. As many readers know, I recently refinanced and was surprised to look at one of my first few statements to realize that more than 2/3rds of my loan payment was going towards principal. It made me wonder what all these folks were talking about, so I thought I'd look into it a little closer.
Let's Ignore The Mortgage Escrows
To make things easy, I'm going to ignore the costs of taxes and insurance. While those are obvious costs of being a homeowner, they really shouldn't be considered part of your mortgage, since you still have to pay them even after the mortgage is “paid off.” But if you were to include them, the percentage of your payment going toward principal would obviously be lower than my examples demonstrate below.
Comparing Interest Paid on 15 and 30 Year Mortgages
I decided to look at two types of loans, a 15 year fixed loan and a 30 year fixed loan, and to consider what percentage of that payment was going toward principal. I looked at both the first payment, as well as the 120th payment (10 years into the loan.) I also considered how our currently low interest rate environment would affect the results. I was curious which would have the bigger effect- decreasing the length of the mortgage or decreasing the interest rate (although they generally travel together of course.) Here is what I found using the spreadsheet functions “Payment” (PMT) and “Principal Payment” (PPMT). The graph shows the percentage of the payment going toward principal.
| Rate | 15Y 1st PMT | 15Y 120th PMT | 30Y 1st PMT | 30Y 120th PMT |
| 3% | 64% | 86% | 41% | 55% |
| 6% | 41% | 74% | 17% | 30% |
| 9% | 26% | 63% | 7% | 17% |
How Much of My Mortgage Each Month is Interest?
As you can see, the idea that 90% of your payment goes toward interest only applies to a 30 year loan with an interest rate of 8% or higher, and then only for the first few years. If you can get a lower interest rate, and/or shorten the course of the loan, your first payment can be composed of as much as 64% principal, which increases to as much as 86% principal after 10 years. It is also interesting that decreasing the interest rate by 3% has about the same effect on the percentage as cutting the loan term in half. Decreasing the interest rate by 6% has about the same effect as paying down the loan for a decade.
Conclusions on How Much Mortgage Payments Goes Towards Interest
Anyone whose mortgage payment is 90% interest needs to refinance. Refinancing to a lower rate (while keeping the term the same), paying extra principal, and using a shorter mortgage are good ways to minimize the interest costs of buying a house, although doing so doesn't necessarily leave you better off financially if the opportunity cost is too high.
What do you think? Were you surprised by the results? Comment below!
I am not all surprised by the results.. Great way to look at the details from a high level and compare what people are really getting into.
So glad I refinanced taking advantage of lower rates and converting from a 30 year to a 15 year. It is already making a nice impact to my bottom line. In another 5 years.. it should reflect some respectable gains for sure!!!
this is similar to the i pay 50% in taxes….people like to say it even if it isnt true.
It’s a good idea to be aware of how much of your monthly payment is actually going towards paying down your principal, thanks for pointing that out. It takes the main focus off of the monthly payment amount and more on the actual cost of the loan. It will help you own your home more quickly and pay less for it in the long run.
This is representative of an ideal world. Unfortunately this is not how amorization is calculated by banks. Though you are right that the payment on interest decreases with a lower rate, look at an amorization calculator to understand how lenders apply your payment to the principle.
Would you mind explaining how amortization is calculated by banks, particularly how it differs from the examples used in the post? As near as I can tell, the amortization charts/calculators I’ve used in the past work exactly like this.
Skip refinancing if you are in a higher value home with a high interest jumbo mortgage and have a low LTV (Loan to Value) ratio.
Instead, relentlessly seek a mortgage rate adjustment.
This advice is even more poignant if you have a physician loan. Mortgage brokers are smart. They understand you can make the payments so they give you a little more for a higher interest rate. Your “type” almost NEVER defaults. They also know that it would be very expensive for you to refinance to a lower rate in the first 5-7 years because of a relatively low LTV ratio. They have you trapped.
Be smart, don’t go to your original physician loan broker and ask for adjustment. You will get nothing but smoke and mirrors. You will need to find another loan officer in the same bank or mortgage company who does NOT broker physician loans and ask how to apply for an adjustment.
Adjustments are typically made by a separate office within the bank or mortgage company. They ignore LTV as long as your payments are up to date. The program is designed to keep more home owners in their current mortgages with the same bank or mortgage company as rates fall.
A mortgage loan adjuster will typically look at your loan and offer a one time adjustment to the current market rate or allow adjustment of a loan to a longer fixed term (or both.) This is especially true if you are in a higher interest Jumbo ARM.
I was two and a half years in to a high interest 5 year jumbo ARM on a higher value home which was a stretch while I was still in the military. After I separated, I attempted refinancing several times after rates fell like a rock only to realize the costs were staggering. I had lost all hope and decided to ride it out. At least, I though, I could ride the ARM to a lower rate.
A friend who was a loan officer at another bank tipped me off on how to seek an adjustment. The adjustment took 3 months of constant pursuit, but it only cost me $2500 and dropped my interest rate to less than half it was before. It also allowed me to lock the rate in for 30 years.
Needless to say, I feel like I won the lottery. Along with the drop in rate, the payments fell like a rock. The adjustment also did not reset me to 30 years. Instead, it allowed me to keep the two and a half years of payments that I had earned.
Unaware of the adjustment, my original physician loan broker called me up 3 months after the completion of the adjustment seeking to refinance me again with a worse rate and significantly higher refinance cost. I laughed at him and ask him why he had never offered me an adjustment. His reply was, “We all gotta eat.” He then hung up on me.
Just because a loan goes back out to 30 years doesn’t mean you can’t pay it off in 2 1/2. You just send in a little extra each month and voila it’s a 27 1/2 year mortgage.
You can often keep refinancing costs very low by doing a “no-cost” refinance as well.
How about look at an “amortization table” to determine the specifics of each loan product. Anyone that thinks they pay 90% in interest is a knucklehead. I have a 10 year fixed and about 75.00% of my payment currently goes to principal. If anyone doesn’t know how to read an amortization table they probably shouldn’t be buying a house in the first place.