principal and interest explained

What is ‘Principal and Interest’ on a Home Loan?

Rates and Fees verified correct on January 17th, 2017

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.

One of the most common bits of jargon found on finder.com.au and indeed any home loan advertisement is the phrase ‘principal and interest’.

If you scratch your head whenever it crops up fear not, our mortgage 101 class has just begun.

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.

1st month of repayments

Principal Interest

Based on a $250,000 loan at 5.70% p.a. over 25 years.

This is because at the beginning of the loan 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.

You may then ask 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.

236th month of repayments

month 226 of Principal and interest

Based on a $250,000 loan at 5.70% p.a. over 25 years.

Compare Principal and Interest Home Loans

Rates last updated January 17th, 2017
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Loan purpose
Offset account
Loan type
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Interest Rate (p.a.) Comp Rate^ (p.a.) Application Fee Ongoing Fees Max LVR Monthly Payment
NAB Choice Package Home Loan - 2 Year Fixed (Owner Occupier)
A fixed rate package loan with flexible repayments options.
3.98% 4.87% $0 $395 p.a. 95% Go to site More info
Greater Bank Ultimate Home Loan - Discounted 1 Year Fixed ($150K+ Owner Occupier)
Discount off an already competitive interest rate for loans over $150k. NSW, QLD and ACT residents only.
3.59% 4.42% $0 $375 p.a. 85% Go to site More info
3.74% 3.74% $0 $0 p.a. 80% Go to site More info
State Custodians Standard Variable Spring Special - LVR 80% (Owner Occupier)
Special Owner Occupier Rate. Free Offset Account.
3.59% 3.92% $0 $299 p.a. 80% Go to site More info
IMB Accelerator Home Loan  - LVR <=80% $300k+ (Owner Occupier)
A two year discounted rate which reverts to an ongoing life of loan discount afterwards.
3.64% 4.39% $445 $0 p.a. 80% Go to site More info
ME Flexible Home Loan With Member Package - LVR <=80% $400k up to $699,999 (Owner Occupier)
Enjoy a discount of a competitive interest rate and 100% offset account.
3.94% 4.35% $0 $395 p.a. 80% Go to site More info
loans.com.au Essentials - Variable (Owner Occupier, P&I)
A low-interest rate loan suited for refinancing with no application or ongoing fees.
3.59% 3.61% $0 $0 p.a. 80% Go to site More info
Newcastle Permanent Building Society Premium Plus Package Home Loan - New Customer Offer ($150,000+ Owner Occupier)
Apply for a new owner occupier loan or refinance from another lender and receive this discounted rate.
3.74% 4.12% $0 $395 p.a. 95% Go to site More info
State Custodians Breathe Easy Spring Special  - LVR 80% (Owner Occupier)
Special Owner Occupier Rate. Free Offset Account.
3.72% 3.75% $0 $0 p.a. 80% Go to site More info
CUA Fixed Rate Home Loan - 2 Year Fixed (Owner Occupier)
A fixed home loan with no ongoing fees and flexible repayments options.
3.69% 4.56% $600 $0 p.a. 95% Go to site More info
IMB Budget Home Loan - LVR <=90% (Owner Occupier)
A competitive budget rate without any unwanted bells and whistles.
3.87% 3.92% $445 $0 p.a. 90% Go to site More info
Australian Unity Kick Starter Home Loan
$0 ongoing service fees, maximum 80% LVR and a linked transaction account.
3.79% 3.82% $600 $0 p.a. 80% Go to site More info
ING  DIRECT Orange Advantage Loan - $150,000+ (LVR <= 80% Owner Occupier)
A fully featured home loan with an offset account and discounts available.
3.89% 4.11% $0 $199 p.a. 80% Go to site More info
Beyond Bank Low Rate Special Home Loan
A special low variable rate for Owner Occupier with 100% offset account and no application or ongoing fees.
3.73% 3.73% $0 $0 p.a. 70% Go to site More info
Switzer Home Loan
No upfront or ongoing fees and a competitive variable rate for owner occupiers.
3.89% 3.89% $0 $0 p.a. 90% Go to site More info
3.94% 4.33% $0 $395 p.a. 90% More info
ME Flexible Home Loan Fixed - 3 Year Fixed Rate (Owner Occupier)
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
CUA Kick Start Variable Home Loan - 2 Years Introductory (Owner Occupier)
Borrow up to 90% LVR and enjoy an introductory rate for the first 2 years.
3.69% 3.87% $600 $0 p.a. 90% Go to site More info
Heritage Bank Discount Variable Home Loan - Special Rate Offer (Owner Occupier)
A low rate variable home loan offer with no monthly fees or application fee charge.
3.79% 3.84% $600 $0 p.a. 95% Go to site More info
Greater Bank Great Rate Home Loan - Discounted Variable ($150K+ Owner Occupier)
A competitive rate with redraw facility. NSW, QLD and ACT residents only.
3.89% 3.89% $0 $0 p.a. 85% Go to site More info
RAMS Fixed Rate Home Loan - 2 Year Fixed Rate (Owner Occupier, P&I)
Fix your interest rate for 2 years to know your budget.
4.14% 5.22% $595 $20 monthly ($240 p.a.) 95% Go to site More info
Newcastle Permanent Building Society Fixed Rate Home Loan - 2 Years Fixed (Owner Occupier)
Enjoy a low interest rate and borrow up to 95% (with LMI) of your home value.
4.24% 4.86% $0 $0 p.a. 95% Go to site More info
State Custodians Standard Variable Spring Special - LVR 90% (Owner Occupier)
A special rate for owner occupiers with free 100% offset account and no application fee.
3.69% 4.02% $0 $299 p.a. 90% Go to site More info
AMP Essential Home Loan  -  Owner Occupier
Take advantage of a redraw facility, competitive variable rate and no application or settlement fees for a limited time.
3.98% 4.00% $350 $0 p.a. 90% Go to site More info
Newcastle Permanent Building Society Fixed Rate Home Loan - 1 Year Fixed (Owner Occupier)
Get a short term fixed rate for that investment property with no application or ongoing fees.
4.24% 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 with no application fees for a limited time.
4.10% 4.14% $600 $0 p.a. 95% Go to site More info
Switzer Fixed Rate Home Loans - 2 Years Fixed Rate
A competitive 2 year fixed rate with your very own lending service manager.
3.97% 3.99% $0 $0 p.a. 80% Go to site More info
Australian Unity Health, Wealth and Happiness Package - (Owner Occupier)
Get a 0.60% discount on your rate, a 100% offset account and no ongoing fees.
3.99% 4.02% $600 $0 p.a. 90% Go to site 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.
4.40% 4.79% $0 $395 p.a. 95% Go to site More info
ME Flexible Home Loan Fixed - 2 Year Fixed Rate (Owner Occupier)
No application or ongoing fees and a competitive 2 year fixed rate.
3.94% 4.85% $0 $0 p.a. 95% Go to site More info
IMB Essential Home Loan - LVR < 80% (Owner Occupier)
Access to redraw facility and offset account without the annual fee.
4.09% 4.09% $0 $0 p.a. 80% Go to site More info
NAB Choice Package Home Loan - 5 Year Fixed (Owner Occupier)
A competitive loan with flexible features.
4.59% 5.02% $0 $395 p.a. 95% Go to site More info
Westpac Flexi First Option Home Loan - 3 Years Introductory Special Offer (New Owner Occupier, P&I)
A limited time deal for new owner occupiers. Advertised rate includes 1.03%p.a. discount for the first two years.
3.99% 4.37% $0 $0 p.a. 95% 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% 5.00% $0 $395 p.a. 95% 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 cash back available for refinancers, conditions apply.
3.99% 5.04% $0 $395 p.a. 95% More info
Westpac Fixed Options Home Loan Premier Advantage Package - 2 Years
A low interest rate home loan with a low service fee.
4.19% 5.32% $0 $395 p.a. 95% 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%.
4.08% 4.09% $0 $0 p.a. 95% More info
Australian Unity Wealth Builder Investor Package Home Loan - Variable
An investment loan with no ongoing fees and borrow up to 90% LVR.
4.19% 4.22% $600 $0 p.a. 90% Go to site More info

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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, are widely available to many borrowers. These loans 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.

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 of 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?
Title

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.

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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ME Basic Home Loan - LVR <=80% Owner Occupier

A low variable rate loan with no application or ongoing fees.

NAB Choice Package Home Loan - 3 Year Fixed (Owner Occupier)

Receive discounts on interest rates with the Choice Package.

Newcastle Permanent Building Society Premium Plus Package Home Loan - New Customer Offer ($150,000+ Owner Occupier)

Apply for a new owner occupier loan or refinance from another lender and receive this discounted rate.

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