🎂 Turned 31 this year? Get health insurance before your price rises.
Get cover
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 June 22nd, 2018
$
Loan purpose
Offset account
Loan type
Your filter criteria do not match any product
Name Product Interest Rate (p.a.) Comp Rate^ (p.a.) Application Fee Ongoing Fees Max LVR Monthly Payment Short Description
3.69%
3.69%
$0
$0 p.a.
80%
Get $1,000 cash into a USaver account when you apply for a loan of $200,000 or more (new or refinance). Terms and conditions apply. Enjoy flexible repayments, a redraw facility and the ability to split your loan. Plus, pay no application or ongoing fees.
3.64%
3.66%
$0
$0 p.a.
80%
Pay no ongoing fees and enjoy a flexible repayment schedule, including the ability to make unlimited additional repayments without penalty.
3.69%
3.69%
$0
$0 p.a.
70%
Pay no application or ongoing fees and get a flexible loan with the ability to split up to 6 times.
3.69%
4.11%
$0
$395 p.a.
80%
Save on interest with a 100% offset account and save on other ME products with this package loan.
3.49%
4.49%
$0
$395 p.a.
90%
Loans over $150k get a discount off an already low fixed rate. Available for NSW, Qld and ACT residents only.
3.52%
3.53%
$0
$0 p.a.
80%
Go from application to approval in as little as 20 minutes with a variable rate loan from this innovative online lender. Add a 100% offset account for $10 a month.
3.69%
3.70%
$0
$0 p.a.
90%
Package your loan and get an interest rate discount, a 100% offset account and help from an HSBC relationship manager.
3.64%
3.67%
$0
$0 p.a.
80%
This loan offers a competitive variable rate and a 100% offset account to help save you on interest repayments.
3.73%
3.76%
$0
$0 p.a.
80%
This basic loan offers discounts for higher borrowing amounts and carries no ongoing fees.
3.64%
3.67%
$0
$0 p.a.
80%
A mortgage with a competitive variable rate, limited fees and plenty of flexibility.

Compare up to 4 providers

Aussie Home Loans Logo

Enter your details below to receive an obligation-free quote from an Aussie home loans expert today

finder.com.au guarantees the privacy and security of your details

Applications are subject to approval. Conditions, fees and charges apply. Please note that you need to be an Australian citizen or permanent resident to apply.

Credit services for Aussie Select, Aussie IQ and Aussie Optimizer products are provided by AHL Investments Pty Ltd ACN 105 265 861 Australian Credit Licence 246786 ("Aussie"), and its appointed credit representatives. Credit for Aussie Select products is provided by Residential Mortgage Group Pty Ltd ACN 152 378 133 Australian Credit Licence 414133 (“RMG”). RMG is a wholly-owned subsidiary of the Commonwealth Bank of Australia ABN 48 123 123 124 AFSL and Australian Credit Licence 234945. Credit for Aussie Optimizer products is provided by Perpetual Limited ABN 86 000 431 827 (Lender). Credit for Aussie IQ is provided by Macquarie Bank Limited ABN 46 008 583 542 AFSL and Australian Credit Licence 237502. Home loans issued by the Lender are serviced by Macquarie Securitisation Limited ABN 16 003 297 336, Australian Credit Licence 237863 (MSL).

Aussie is a trade mark of AHL Investments Pty Ltd. Aussie is a subsidiary of the Commonwealth Bank of Australia ABN 48 123 123 124. ©2018 AHL Investments Pty Ltd ABN 27 105 265 861 Australian Credit Licence 246786.

By submitting this form, you agree to the finder.com.au privacy policy and the Aussie privacy policy.

Aussie Home Loans is both a lender and a mortgage broker, and offers a range of services.

  • FREE Suburb and Property Report with every appointment.
  • Access 3,000+ loans from over 20 lenders.
  • Get expert help with your loan application, including paperwork and eligibility.
  • Over 1000 brokers who are able to help you in your local area.

Aussie Home Loans Lender Logos

The Adviser’s number 1 placed mortgage broker 5 years running (2013-2017)

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.

Not what you're looking for? Compare a wide range of home loans here

Marc Terrano

Marc Terrano is a content marketer manager at finder. He's been writing and publishing personal finance content for over five years and loves to help Australians get a better deal.

Was this content helpful to you? No  Yes

Related Posts

Home Loan Offers

Important Information*
loans.com.au Essentials - Variable (Owner Occupier, P&I)

A competitive interest rate home loan with interest only options. Interest rate 3.64%p.a.
comp rate of 3.66%p.a.

UBank UHomeLoan Variable Rate - Discount Offer for Owner Occupied Variable P&I Rate — borrowing $700,000 or more

Pay no application or ongoing fees and get access to a redraw facility and flexible repayment schedule. Get $1,000 cash into a USaver account when you apply for a loan of $200,000 or more. Terms and conditions apply.

Greater Bank Ultimate Home Loan - Discounted 1 Year Fixed LVR ≤90% ($150K+ Owner Occupier)

Loans over $150k get a discount off an already low fixed rate. Available for NSW, Qld and ACT residents only.

Ask an Expert

You are about to post a question on finder.com.au:

  • Do not enter personal information (eg. surname, phone number, bank details) as your question will be made public
  • finder.com.au is a financial comparison and information service, not a bank or product provider
  • We cannot provide you with personal advice or recommendations
  • Your answer might already be waiting – check previous questions below to see if yours has already been asked

Finder only provides general advice and factual information, so consider your own circumstances, or seek advice before you decide to act on our content. By submitting a question, you're accepting our Terms and Conditions and Privacy Policy.
Ask a question
Go to site