To calculate principal and interest, you can use some straightforward math, but you'll need to know your loan type first. Interest is typically calculated in one of two ways: as simple interest or on an amortized schedule. With simple interest, the amount of your interest payments remains the same and with amortized interest, you pay more toward interest at the beginning of the loan. Learn more about how to calculate the principal and interest of a loan like a mortgage.

Principal and Interest

When you make a loan payment, part of it goes toward interest payments and part goes to pay down your principal. Understanding how banks calculate these components can help you understand how you will pay your loan down.

Principal

The principal is the original loan amount not including any interest. For example, with mortgages, let's suppose you purchase a $350,000 home and put down $50,000 in cash. That means you’re borrowing $300,000 of principal from the lender, which you'll need to pay back over the length of the loan.

Interest

The interest is the amount that bank also charges for lending you those funds. Generally, shorter term, fixed-rate loans like personal loans use a simple interest calculation. Longer-term loans like mortgages and some auto loans are amortized.

Example of mortgage interest calculation

Let’s say the loan in the example above is a 30-year mortgage with a 4% annual interest rate that is amortized. Since you’re making monthly, rather than annual, payments throughout the year, the 4% interest rate gets divided by 12 and multiplied by the outstanding principal on your loan. In this example, your first monthly payment would include $1,000 of interest ($300,000 x 0.04 annual interest rate ÷ 12 months). 

If you plug your purchase price, your down payment, the length of your loan, and your APR into the Investopedia Mortgage Calculator, you will see that your monthly payments to the lender would equal $1,432.25. As we noted earlier, $1,000 of your first payment strictly covers the interest cost, meaning the remaining $432.25 is paying down your outstanding loan balance or principal.  

The example above doesn't include other costs, such as mortgage insurance and property taxes held in escrow, which are not paid to the lender.

How Amortization Works

If you have a fixed-rate loan, your mortgage payment stays the same each month. In theory, that interest rate is being multiplied by a shrinking principal balance. The reason the amount you pay does not decline is that lenders use amortization when calculating your payment, which is a way of keeping your monthly bill consistent.

Example of Amortization

Sticking with our earlier example and assuming you don’t refinance, your loan payment will be the same 15 years later. But your principal balance will be reduced. In 15 years, you would have a remaining balance of approximately $193,000 of the principal on your loan. Multiplying $193,000 by the interest rate (0.04 ÷ 12 months), the interest portion of the payment is now only $645.43. However, you’re paying off a bigger portion of the principal, meaning $786.82 of the $1,432.25 monthly payment is going toward the principal.

The table below shows the monthly payments at various points in the 30-year mortgage. You'll notice that the interest portion of the monthly payment declines while the principal portion increases over the life of the loan. You can use an amortization calculator to help you determine your own loan's interest and principal amounts.

Mortgage Loan Amortization With Principal and Interest Breakdown
Year	Principal	Interest	Monthly Payment
Year One	$432.25	$1,000	$1,432.25
15 Years	$786.82	$645.43	$1,432.25
20 Years	$960.70	$471.54	$1,432.25
30 Years	$1,427.49	$4.76	$1,432.25

During the last year of your mortgage, you’re paying off mostly principal and very little interest. By leveling out your payments like this, lenders are making your payments more manageable. If you paid the same amount in principal over the course of the loan, you’d have to make much higher monthly payments right after taking out the loan and those amounts would plummet at the tail end of the repayment. 

If you’re wondering how much you’ll pay toward principal versus interest over time, the Investopedia Mortgage Calculator also shows the breakdown of your payments over the length of your loan. 

Adjustable-Rate Mortgages

If you take out a fixed-rate mortgage and only pay the amount due, your total monthly payment will stay the same over the course of your loan. The portion of your payment attributed to interest will gradually go down, as more of your payment gets allocated to the principal. But the total amount you owe won’t change.

However, it doesn’t work that way for borrowers who take out an adjustable-rate mortgage (ARM). They pay a given interest rate during the initial period of the loan. But after a certain length of time—say, one year or five years, depending on the loan—the mortgage “resets” to a new interest rate. Often, the initial rate is set below the market rate at the time you borrow and then increases following the reset.

Interest Rate vs. APR 

When receiving a loan offer, you may come across a term called the annual percentage rate (APR). The APR and the actual interest rate that the lender is charging you are two separate things, so it’s important to understand the distinction. 

Unlike the interest rate, the APR factors in the total annual cost of taking out the loan, including fees such as mortgage insurance, discount points, loan origination fees, and some closing costs. It averages the total cost of borrowing over the duration of the loan. 

It’s important to realize that your monthly payment is based on your interest rate, not the annual percentage rate. However, lenders are required by law to disclose the APR on the loan estimate they provide after you submit an application, so that you can have a more accurate picture of how much you’re actually paying to borrow that money.

Some lenders may charge you a lower interest rate but charge higher upfront fees, so including the APR helps provide a more holistic comparison of different loan offers. Because the APR includes associated fees, it’s higher than the actual interest rate.

Frequently Asked Questions (FAQs)

The Bottom Line

You likely know how much you're paying to the mortgage servicer each month. But figuring out how that money is divided between principal and interest can help you understand how your loan will be paid down. You can make those calculations yourself or turn to an online loan calculator.