Principal and Interest

The principal is what you borrowed; the interest is the rent the lender charges on it. A principal-and-interest repayment covers both: the month's interest first, then a slice of the actual debt. The balance falls a little every month, and the interest bill falls with it. On a $600,000 loan at 6 percent over 30 years, the repayment is $3,597 a month. Month one is roughly $3,000 of interest and $597 of principal.

The alternative is an interest-only loan, where the repayment covers the interest alone and the balance never falls. Interest-only is standard for investors for a window of up to five years and rare for owner-occupiers. The borrower who pays only interest owns exactly as much of the house on day 1,825 as on day one. When the window ends, the loan reverts to P&I repayments calculated over the remaining term. The repayment jumps, because the same debt now has fewer years to be repaid in.

The amortisation is the mechanism. The repayment is calculated so the loan reaches exactly zero on the final payment: on $600,000 at 6 percent over 30 years, that is $3,597 a month. In month one the interest is $600,000 multiplied by 0.5 percent - $3,000 - and the remaining $597 reduces the principal. In month two the interest is calculated on $599,403, so slightly less interest is charged and slightly more principal is repaid. The interest slice shrinks and the principal slice grows, month after month, for 360 payments.

The early years are mostly interest, which is the part nobody quotes. After 15 years of payments - roughly $647,000 paid in total - the balance on the same loan is roughly $426,000, still 71 percent of what was borrowed. Total interest over the full 30 years is roughly $695,000: more than the original loan, which is the honest cost of a 30-year mortgage at 6 percent.

Extra repayments exploit the mechanism. Paying $1,799 a fortnight - half the monthly repayment, twenty-six times a year - adds one extra monthly repayment annually and cuts the term to roughly 24.5 years. Total interest falls to roughly $546,000: about $149,000 saved, because every extra dollar repaid early stops accruing 6 percent forever. The fortnightly mortgage calculator runs the comparison, and the offset account entry covers the alternative that parks savings rather than repaying them.

For an Australian reader, P&I is the default repayment on a home loan and the mechanism behind every mortgage comparison. MoneySmart's guidance on choosing a home loan treats principal-and-interest as the standard setting, with interest-only as the exception that needs a reason. The arithmetic explains why the first years feel like treading water: the balance barely moves because the interest slice dominates. It also explains why refinancing back to a fresh 30-year term every few years resets the amortisation. The repayment drops, the term restarts, and the lifetime interest compounds across the resets.

A colleague named Brent (yes, that Brent) spent five years paying interest-only on the home he lived in because the minimum repayment was smaller. The balance never moved, the interest charged full freight every month. The reversion to P&I over the remaining 25 years lifted his repayment by roughly $700 a month overnight. The highest-leverage thing most Australians can do is pay P&I from day one and add whatever extra the budget survives. The mortgage calculator shows what one extra monthly repayment a year does to the term and the interest.