With mortgages, "P&I" refers to principal and interest. This is the portion of your monthly mortgage payment that goes toward paying off the money you borrowed to buy your home. For most homeowners, P&I makes up the bulk of their monthly payment – but not all of it.
What Goes Into the P&I Payment
How much your mortgage P&I payment will be depends on three factors:
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- How much you borrow to buy your home. This is the principal. The more you borrow, the higher the P&I payment will be, since you're paying back more money.
- The interest rate on your mortgage. The higher the interest rate, the higher the P&I payment, since you are paying more for the loan.
- The length of the loan. The shorter the loan term, the higher the P&I payment, since you are paying back the loan in fewer payments.
Lenders calculate your monthly P&I payment using an amortization formula. This formula takes into account all three factors and produces a single monthly P&I payment that stays consistent. At the beginning of the loan, the P&I payment is mostly interest, with a relatively small amount going toward the principal. As you pay down the mortgage, however, principal makes up a greater portion of each P&I payment.
Fixed vs. Adjustable Rates
When you have a fixed-rate mortgage – meaning one in which your interest rate is locked in for the life of the loan – your P&I payment will never change. If it's, say, $1,200 at the start, it will be $1,200 at the end. The only difference is that the first payment might be $100 in principal and $1,100 in interest, while the last payment might be $1,180 in principal and $20 in interest.
If you have an adjustable-rate mortgage, however, your interest rate can rise and fall according to conditions in the market. Whenever your rate changes, your lender will recalculate your P&I payment based on the new interest rate. That new payment will then stay consistent until your rate changes again.
Taxes and Insurance Explained
For many homeowners, the P&I payment is only one part of their monthly mortgage bill. Often, homeowners pay their property taxes and their hazard insurance as part of their monthly mortgage payment. Typically, the homeowner pays one-twelfth of these costs each month. The lender collects this money from the payments, sets it aside in a special account called an escrow account, and then uses it to pay the property tax and insurance bills once they come due.
This not only offers convenience for the homeowner, but also assures the lender that its investment in the property is protected against both physical damage and tax liens. The total mortgage payment is sometimes referred to as a PITI payment, for "principal, interest, taxes and insurance."
The Amortization Formula
The basic amortization formula lenders use to calculate a P&I payment has four variables: P, R, N and M. "P" is the principal, or the amount you borrowed. "R" is the monthly interest rate on the loan, expressed as a decimal. A 6 percent annual interest rate, for example, would be 0.5 percent per month, or 0.005. "N" is the number of months in the loan term.
For a 30-year loan term, for example, N would be 360; for a 15-year loan, N would be 180. "M" is the monthly P&I payment.
The formula is: M = P x [R x (1 + R)N] / [ (1 + R)N– 1]