The monthly payment that is set to include: the interest that has accrued and enough principal reduction so that the loan will be paid off during the term of the loan.
For example, note the following in the below snippet of an amortization schedule:
The 1st month, the $333.33 interest that accrued during the month is based on the loan balance ($100,000) and the monthly rate (4% / 12)
– The scheduled payment of $477.42, covers the $333.33 in interest that accrued and $144.42 in principal reduction
The 2nd month, the $332.85 interest that accrued during the month is based on the loan balance ($99,855.92) and the monthly rate (4% / 12)
– The scheduled payment of $477.42, covers the $332.85 in interest that accrued and $144.56 in principal reduction
As you can see, each month:
1. the loan amount is reduced (due to principal reduction)
2. the interest accrued is lower (due to lower loan amount)
3. the principal reduction is higher (due to fixed payment and lower interest accrual)
This continues until the end of the term of the loan, at which time the balance of the loan is zero.
Interested in paying off your loan faster?
Payoff your loan roughly 5 years earlier, by paying an extra 10% of your mortgage payment towards the principal each month.
– For example, based on the below amortization schedule, if an extra monthly payment of $47.74 ($477.42 x 10%) was made each month, the loan would be paid off roughly 5 years earlier.