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principal and interest explained

What is ‘principal and interest’ on a home loan?

Learn about one of the most basic details of your home loan and how to make use of it to pay your loan off quicker.

The phrase "principal and interest" is top of mind for many borrowers at the moment. Recent moves by the Australian Prudential Regulation Authority (APRA) have seen many lenders cut rates on principal and interest home loans while raising rates for interest-only borrowers. These rate moves have grabbed media attention, as lenders try to incentivise interest-only borrowers to move to principal and interest repayments.

If all that media coverage has you scratching your head, fear not: We're here to demystify principal and interest repayments for you.

Put simply, a principal and interest payment means your repayment is divided up into two portions. Some is sent towards paying off the interest due on your outstanding loan amount, while the remainder goes towards paying off the outstanding loan amount itself.

What does principal and interest mean? Principal is how much money you borrowed from the bank. Interest is the extra money you have to pay back for borrowing that money.

Interest and Principal breakdown

Why can the amounts of interest and principal I pay change over the course of my loan?

If you take out a loan in which repayments go towards both the interest and principal payments, you’ll notice most of your repayment will go towards interest at the beginning of the loan and only a small amount will go towards the principal.

Look at the two graphs below, based on a $250,000 loan at 5.70% p.a. over 25 years.

In the first month of repayments you’re paying interest on the whole amount you’ve borrowed, but as this amount is paid off over the years, the interest due is smaller.

But if you’re paying less interest and the principal is getting smaller, why are your repayments not getting smaller?

This is because your lender has worked out exactly how much you’ll need to spend on each repayment to pay off your loan in the term you’ve agreed to. The result of these calculations is called an amortisation schedule. The schedule shows how much of your payments go towards interest and how much goes towards principal payments and this will show that the amount that goes towards paying off the principal gets bigger as the years go on and does so at a faster rate.

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Interest Rate (p.a.) Comp Rate^ (p.a.) Application Fee Ongoing Fees Max LVR Monthly Payment
loans.com.au Essentials - Variable (Owner Occupier, P&I)
A basic home loan with a competitive rate and low fees.
3.64% 3.66% $0 $0 p.a. 80% Go to site More info
Greater Bank Ultimate Home Loan - Discounted 1 Year Fixed LVR ≤85% ($150K+ Owner Occupier)
Discount off an already competitive interest rate for loans over $150k. NSW, QLD and ACT residents only.
3.59% 4.48% $0 $375 p.a. 85% Go to site More info
UBank UHomeLoan Variable Rate - Standard Variable Rate Value Offer (Owner Occupier P&I)
Combine a low variable interest rate and free redraw with no application or ongoing fees.
3.74% 3.74% $0 $0 p.a. 80% Go to site More info
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loans.com.au Offset Variable - Up to 80% LVR (Owner Occupier P&I)
Take advantage of a 100% offset account along with no annual or application fees.
3.72% 3.74% $0 $0 p.a. 80% Go to site More info
NAB Choice Package Home Loan - 2 Year Fixed (Owner Occupier P&I) First Home Buyer Special
A special rate for first home buyers buying residential property and borrowing over $150K. 350K NAB Rewards Points offer available. Terms and conditions apply.
3.69% 4.86% $0 $395 p.a. 90% Go to site More info
ING DIRECT Orange Advantage Loan - $150,000+ (LVR <=80% Owner Occupier, P&I)
A fully featured home loan with an offset account and discounts available. $1000 cashback offer available for loans over $300k. Terms and conditions apply.
3.79% 4.11% $0 $299 p.a. 80% Go to site More info
HSBC Home Value Loan - Resident Owner Occupier only
Enjoy a low variable rate with no ongoing fees and borrow up to 90% of the value of the property.
3.85% 3.86% $0 $0 p.a. 90% Go to site More info
Newcastle Permanent Building Society Fixed Rate Home Loan - 2 Year Fixed (Owner Occupier Special Rate, P&I)
Owner-occupiers can lock in a competitive rate with no ongoing fees. Conditions apply.
3.84% 4.86% $0 $0 p.a. 95% Go to site More info
SCU Basic Variable Rate Home Loan
A basic home loan with a low interest rate and a redraw facility available. Take out a new SCU loan and enjoy $500 cash back on loans above $150k, terms and conditions apply.
3.77% 3.81% $200 $0 p.a. 95% Go to site More info
NAB Choice Package Home Loan - 2 Year Fixed (Owner Occupier P&I)
A fixed rate package with flexible repayment options. 350K NAB Rewards Points offer available. Terms and conditions apply.
3.88% 4.89% $0 $395 p.a. 95% Go to site More info
ClickLoans The Online Home Loan - Owner Occupier ≤ 80% LVR, P&I
Enjoy a competitive variable interest rate, no application fee, limited annual fees and an offset account with redraws.
3.69% 3.69% $0 $0 p.a. 80% Go to site More info
Greater Bank Great Rate Discount Variable with Family Pledge Home Loan - Up to 110% LVR
Discounted rate available with family pledge loans. Family pledge loans require no LMI and no deposit. NSW, Qld and ACT only.
3.99% 3.99% $0 $0 p.a. 110% Go to site More info
IMB Budget Home Loan - LVR <=90% (Owner Occupier)
Get a competitive rate without features you may not use.
3.97% 4.02% $445 $0 p.a. 90% Go to site More info
Finsure Home Loan Deal
Enjoy a low variable rate with no application fee.
3.69% 4.03% $0 $299 p.a. 80% Enquire now More info
Heritage Bank Discount Variable Home Loan - Special Rate Offer (Owner Occupier) New Customers Only
A low rate variable home loan offer with no monthly fees or application fee charge.
3.99% 4.04% $600 $0 p.a. 90% Go to site More info
SCU My Life Fixed Rate Home Loan Package - 3 Years
Fix your rate for 3 years and borrow up to 95% LVR. Enjoy $500 cashback on new loans above $150k. Terms and conditions apply.
3.69% 4.00% $0 $350 p.a. 95% Go to site More info
ME Flexible Home Loan Fixed - 2 Year Fixed Rate (Owner Occupier, P&I)
No application or ongoing fees and a competitive 2 year fixed rate.
3.74% 4.81% $0 $0 p.a. 95% Go to site More info
Greater Bank Ultimate Home Loan - Discounted 2 Year Fixed LVR ≤85% ($150K+ Owner Occupier)
Discount off an already competitive 2 year fixed rate for loans over $150k. NSW,QLD and ACT residents only.
3.79% 4.46% $0 $375 p.a. 85% Go to site More info
State Custodians Low Rate LOC - LVR up to 80% (Owner Occupier)
Access the equity in your home with a competitive interest rate and no application fee.
3.69% 3.72% $0 $0 p.a. 80% Go to site More info
Beyond Bank Low Rate Special Home Loan - LVR <70%
A special low variable rate for owner occupiers with 100% offset account and no application or ongoing fees.
3.83% 3.83% $0 $0 p.a. 70% Go to site More info
Newcastle Permanent Building Society Premium Plus Package Home Loan - New Customer Offer ($150,000+ Owner Occupier, P&I)
Apply for a new owner occupier loan or refinance from another lender and receive this discounted rate.
3.84% 4.22% $0 $395 p.a. 95% Go to site More info
QT Mutual Bank Mortgage Saver Home Loan
A low rate home loan with no application or ongoing fees. Note that to be eligible for this loan you must be QLD resident.
3.95% 3.95% $0 $0 p.a. 95% Go to site More info
Greater Bank Great Rate Home Loan - Discounted Variable ($150K+ Owner Occupier)
A competitive variable rate with a redraw facility. NSW, QLD and ACT residents only.
3.99% 3.99% $0 $0 p.a. 85% Go to site More info
Newcastle Permanent Building Society Fixed Rate Home Loan - 3 Year Fixed (Owner Occupier Special Rate, P&I)
A limited time fixed rate home loan with extra repayment abilities. Conditions apply.
3.89% 4.78% $0 $0 p.a. 95% Go to site More info
ME Flexible Home Loan Fixed - 3 Year Fixed Rate (Owner Occupier, P&I)
A competitive 3 year fixed rate with a redraw facility and split loan options, plus no application fee.
3.99% 4.77% $0 $0 p.a. 95% Go to site More info
Newcastle Permanent Building Society Fixed Rate Home Loan - 2 Years Fixed (Standard Rate, P&I)
Enjoy a low interest rate and borrow up to 95% (with LMI) of your property's value.
4.14% 4.92% $0 $0 p.a. 95% Go to site More info
NAB Base Variable Rate Home Loan - Owner Occupier (P&I)
A competitive no frills home loan. 350K NAB Rewards Points offer available. Terms and conditions apply.
4.17% 4.21% $600 $0 p.a. 95% Go to site More info
Newcastle Permanent Building Society Fixed Rate Home Loan - 1 Year Fixed (Standard Rate, P&I)
Investors can take advantage of a short term fixed rate with no application or ongoing fees.
4.14% 5.00% $0 $0 p.a. 95% Go to site More info
NAB Choice Package Home Loan - 5 Year Fixed (Owner Occupier P&I)
A competitive loan with flexible features. 350K NAB Rewards Points offer available. Terms and conditions apply.
4.59% 5.01% $0 $395 p.a. 95% Go to site More info
IMB Essential Home Loan - LVR <=90% (Owner Occupier)
Access to redraw facility and offset account without the annual fee.
4.19% 4.19% $0 $0 p.a. 90% Go to site More info
ANZ Simplicity PLUS Home Loan - Special Offer (Owner Occupier, P&I)
Enjoy a basic home loan with a high LVR and no application or ongoing fees.
4.03% 4.07% $0 $0 p.a. 95% Enquire now More info
3.78% 3.79% $600 $0 p.a. 90% Enquire now More info
St.George Basic Home Loan - Promotional Rate (Owner Occupier, P&I)
A no frills loan with a competitive rate and a maximum LVR of 95%.
3.80% 3.81% $0 $0 p.a. 95% Enquire now More info
Commonwealth Bank Wealth Package Fixed Home Loan - 2 Year Fixed (Owner Occupier) P&I
A package home loan with fee free extra repayments available during the fixed term.
3.99% 4.99% $0 $395 p.a. 95% Enquire now More info
St.George Fixed Rate Advantage Package -  2 Year Fixed Rate (Owner Occupier, P&I)
A discounted package rate for owner occupiers with the ability to package a Qantas rewards earning Amplify credit card. $1,500 cashback available for refinancers. Conditions apply.
3.99% 4.98% $0 $395 p.a. 95% Enquire now More info
NAB Choice Package Variable Rate - $250k to $749,999 P&I (Owner Occupier)
A packaged low rate interest offer from NAB. Includes mortgage offset.
4.39% 4.78% $0 $395 p.a. 95% Go to site More info
Westpac Fixed Options Home Loan Premier Advantage Package - 2 Years, P&I
A low interest rate home loan with a low service fee.
3.88% 4.88% $0 $395 p.a. 95% Enquire now More info
4.39% 5.42% $300 $10 monthly ($120 p.a.) 95% Enquire now More info
Virgin Reward Me Variable Home Loan - LVR <= 80% ($750k+ Owner Occupier, P&I)
Earn Velocity points on a competitive variable rate home loan with flexible features.
3.79% 3.92% $0 $10 monthly ($120 p.a.) 80% Enquire now More info

Can you pay ‘principal only’ or ‘interest-only’ payments?

Having a loan where a borrower only paid off the principal would mean that the lender wouldn’t be charging interest and therefore not making any profit.

Sometimes paying no interest is required. In Islam, Muslims are prohibited from ‘usury’ or unfair lending, which means they can’t pay a lender interest. In these cases loans which are principal only are available, although they might be a venture where the lender purchases the property and sells it to the vendor with a built-in profit margin from the start, or a rent-to-own contract.

Interest-only loans, on the other hand take away the amount you’d usually pay towards your principal with each repayment, meaning your repayments are smaller. They’re usually offered for a set amount of years and are popular with investors who want to maintain their cash flow. They also come with some tax benefits. However, these loans are becoming more difficult to obtain due to moves by APRA to cap new interest-only lending at 30%.

How can you pay off your loan faster?

Many borrowers choose to pay off their loan in a principal and interest scheme because it’s a quicker way to pay off your loan. There are even ways to accelerate this further:

100% offset accounts. An offset account reduces the amount of interest you pay, meaning more of your payments go towards the principal. This can save you thousands in interest and years off your loan.

Lump sum payments. Lump sum payments made on a loan at the beginning of the loan term will help pay it off faster. This is because a lump sum payment will pay off the interest due for the repayment and then put a much larger than usual payment towards the principal. As discussed above, the interest you pay is related to how much you still owe, so reducing this amount means you pay less interest and pay the loan off quicker.

Did you know?

Make bi-weekly repayments

If you switch your repayment frequency and make a repayment every two weeks, you’ll actually end up making an extra repayment each year. This is because there’s 26 fortnights in a year, which equates to 13 months of repayments. It may not sound like much, but on a principal and interest loan it could reduce your loan term by up to five years.

Why do we pay interest?

The short answer is a bank is a business and like any other business it wants to make a profit. The interest you pay is part of their profit.

To answer why the interest we pay fluctuates we first need to know where lenders get the money they lend from.

When you apply for a loan, your lender will source funds for you from a range of places.

According to the Reserve Bank of Australia (RBA) almost half of this now comes from the domestic market. This means some of your loan money will be made up of funds taken from other Australian’s savings and term deposit accounts.

The other portion is borrowed from wholesale lenders, which can be from sources such as superannuation funds or other investment funds looking for safe investments.

The more expensive it is for your lender to get a hold of this money the more interest you might have to pay. The cash rate set by the RBA each month also has a significant bearing on how much interest is paid. This is why your repayments can fluctuate each month.

If the RBA lowers the cash rate, it could become cheaper for lenders to source funds for loans and therefore lenders may lower their interest rates. It’s part of the reason why a continual comparison of the other loans in the market is always necessary.

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Marc Terrano

A passionate publisher who loves to tell a story. Learning and teaching personal finance is his main lot at finder.com.au. Talk to him to find out more about home loans.

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Greater Bank Ultimate Home Loan - Discounted 1 Year Fixed LVR ≤85% ($150K+ Owner Occupier)

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