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.

Ready for the next step? Compare Principal and Interest Home Loans

Rates last updated November 20th, 2017
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Name Product Interest Rate (p.a.) Comp Rate^ (p.a.) Application Fee Ongoing Fees Max LVR Monthly Payment Short Description
3.65%
3.66%
$0
$0 p.a.
90%
Enjoy a low variable rate with no ongoing fees and borrow up to 90% of the value of the property.
3.69%
4.86%
$0
$395 p.a.
90%
A special rate for first home buyers buying residential property and borrowing over $150K. 350K NAB Rewards Points offer available. Terms and conditions apply.
3.64%
3.66%
$0
$0 p.a.
80%
A basic home loan with a competitive rate and low fees.
3.49%
4.47%
$0
$375 p.a.
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Discount off an already competitive interest rate for loans over $150k. NSW, QLD and ACT residents only.
3.54%
3.56%
$0
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Exclusive Offer to finder.com.au

This loan is exclusively available on finder up to and including 22 November (enquiries must be submitted by that date). This loan is for refinancers only. A basic but flexible low-rate loan for refinancers looking to save on repayments.

3.58%
3.59%
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$0 p.a.
80%
A competitive variable rate product with low fees offered by a 100% online lender.
3.58%
3.58%
$0
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70%
A low interest rate home loan with no application or ongoing fees.
3.64%
3.66%
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4.14%
4.14%
$0
$0 p.a.
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An investment home loan with competitive rate and 100% offset account.
4.64%
4.01%
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80%
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3.44%
3.45%
$440
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This variable loan has a sharp rate, low fees, flexible repayment options and an offset account. This loan is available for PAYG borrowers only.
3.64%
3.64%
$0
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70%
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3.64%
3.64%
$0
$0 p.a.
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A basic variable home loan that offers a competitive interest rate with no application fees and no ongoing fees.
3.54%
3.56%
$0
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3.69%
3.72%
$0
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80%
A low rate home loan with no ongoing fees.
3.69%
4.01%
$0
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95%
A loan with no application fee and borrow up to 95% LVR.
3.69%
3.69%
$0
$0 p.a.
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4.19%
4.22%
$0
$0 p.a.
90%
Access a fee-free offset account and a special interest rate for investors.
4.79%
5.44%
$0
$395 p.a.
95%
Package your 4-year fixed rate investment loan and pay no application fees.
3.99%
4.62%
$395
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80%
Fix your interest rate and pay principal and interest repayments on your investment.
3.62%
3.64%
$0
$0 p.a.
80%
Exclusive Offer to finder.com.au

This loan is exclusively available on finder up to and including 22 November (enquiries must be submitted by that date). This loan is for refinancers only. Switch from your current loan to this low-rate, flexible and feature-packed refinance special.

3.99%
4.00%
$0
$0 p.a.
80%
A low-fee variable rate investor loan with a fast online application process.
3.78%
3.79%
$0
$0 p.a.
95%
A no frills loan with a competitive rate and a maximum LVR of 95%.
3.74%
3.74%
$0
$0 p.a.
80%
A basic owner-occupier home loan with a low variable rate that requires a 20% deposit.
3.64%
4.03%
$0
$395 p.a.
80%
Apply for a new owner occupier loan or refinance from another lender and receive this discounted rate.
3.65%
4.84%
$0
$395 p.a.
90%
A 2 years fixed platinum package that has $0 application and a loan redraw facility.
3.74%
3.74%
$0
$0 p.a.
80%
Combine a low variable interest rate and free redraw with no application or ongoing fees.
3.79%
4.11%
$0
$299 p.a.
80%
A fully featured home loan with an offset account and discounts available.
3.77%
3.81%
$200
$0 p.a.
95%
A basic home loan with a low interest rate and a redraw facility available.
3.68%
3.83%
$0
$10 monthly ($120 p.a.)
80%
A low interest rate home loan that allows borrowers to borrow up to 80% of the property value.
3.72%
3.74%
$0
$0 p.a.
80%
Take advantage of a 100% offset account along with no annual or application fees.
3.81%
3.81%
$0
$0 p.a.
80%
A home loan with a competitive rate and plenty of handy features.
3.64%
3.78%
$0
$10 monthly ($120 p.a.)
80%
A competitive variable rate home loan with flexible features. You can earn 30,000 Velocity Points for every $100k you borrow (for a limited time, subject to eligibility requirements).
3.88%
3.81%
$0
$0 p.a.
95%
A competitive 3-year fixed rate loan with a high max insured LVR.
3.72%
3.75%
$600
$0 p.a.
80%
A maximum 80% LVR home loan with no ongoing service fees and a linked transaction account.
3.94%
4.88%
$0
$0 p.a.
90%
Enjoy a low interest rate and borrow up to 90% (with LMI) of your property's value.
3.79%
4.00%
$0
$10 monthly ($120 p.a.)
90%
Get a competitive interest rate for 3 years and a discounted variable rate when the fixed period ends.
3.69%
4.15%
$395
$0 p.a.
80%
A one year fixed rate offer with no ongoing bank fees.
3.84%
3.84%
$0
$0 p.a.
110%
Requires a family member to act as guarantor. Discounted rate available with family pledge loans. Family pledge loans require no LMI and no deposit. NSW, Qld and ACT only.
3.97%
4.02%
$445
$0 p.a.
90%
Get a competitive rate without features you may not use.
3.99%
4.02%
$600
$0 p.a.
90%
Take advantage of a 0.60% discount on your rate, a 100% offset account and no ongoing fees.
3.74%
3.74%
$0
$0 p.a.
90%
A competitive variable rate with a redraw facility. NSW, QLD and ACT residents only.
4.09%
4.11%
$0
$0 p.a.
80%
A low variable rate loan with no application or ongoing fees.
3.69%
4.00%
$0
$350 p.a.
95%
Fix your rate for 3 years and borrow up to 95% LVR.
3.85%
4.18%
$500
$0 p.a.
95%
Apply for Easy Street fixed rate home loans and get a competitive loan with a fixed interest rate.
3.69%
3.75%
$600
$0 p.a.
80%
A low interest rate variable home loan with no ongoing fees.
3.96%
3.98%
$0
$0 p.a.
90%
Take advantage of a redraw facility, competitive variable rate and no application or settlement fees for a limited time.
3.72%
4.19%
$0
$0 p.a.
80%
Enjoy a variable 3 year introductory rate with the Bankwest Equaliser Home Loan.
3.97%
4.02%
$0
$0 p.a.
90%
A low rate variable home loan offer with no monthly fees or application fee charge.
3.84%
4.83%
$0
$0 p.a.
95%
Get a competitive 2-year fixed rate with no application or ongoing fees.
3.88%
4.89%
$0
$395 p.a.
95%
A fixed rate package with flexible repayment options. 350K NAB Rewards Points offer available. Terms and conditions apply.
4.09%
4.12%
$0
$0 p.a.
80%
Access the equity in your home with a competitive interest-only rate and no application fee.
3.69%
4.45%
$0
$375 p.a.
90%
Discount off an already competitive 2 year fixed rate for loans over $150k. NSW,QLD and ACT residents only.
3.97%
3.97%
$0
$0 p.a.
90%
A competitive variable rate home loan with no ongoing fees.
3.73%
3.73%
$0
$0 p.a.
70%
A special low variable rate for owner occupiers with 100% offset account and no application or ongoing fees.
$0
$0 p.a.
A basic low-rate home loan that still offers some useful features.
3.74%
3.74%
$0
$0 p.a.
95%
A low rate home loan with no application or ongoing fees. Note that to be eligible for this loan you must be QLD resident.
4.19%
4.19%
$0
$0 p.a.
90%
Access to redraw facility and offset account without the annual fee.
3.69%
3.69%
$0
$0 p.a.
70%
Enjoy a low variable rate with no application and ongoing fees.
3.79%
3.80%
$0
$0 p.a.
80%
A competitive rate with no ongoing monthly fees or application fees.
3.99%
4.03%
$0
$0 p.a.
95%
Enjoy a basic home loan with a high LVR and no application or ongoing fees.
3.85%
4.95%
$0
$395 p.a.
95%
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%
4.99%
$0
$395 p.a.
95%
A package home loan with fee free extra repayments available during the fixed term.
4.39%
5.42%
$300
$10 monthly ($120 p.a.)
95%
Lock in a competitive fixed rate for 3 years.
3.69%
4.03%
$0
$299 p.a.
80%
Enjoy a low variable rate with no application fee.
3.75%
4.44%
$0
$0 p.a.
95%
This competitive introductory rate is a limited time offer for new owner-occupiers
3.68%
3.69%
$600
$0 p.a.
90%
Get a low variable rate along with some important basic features.

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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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