Is a mortgage payment an expense? Payment, debt and the income statement

In short

A mortgage payment is not an expense for its full amount. The expenses of the period are the interest and any fees or penalties. The principal reduces both the money in the account and the debt still owed: it changes the make-up of your net worth without reducing it. That's why a $650 payment with $150 of interest costs $150. The income statement is the document that separates what you pay from what it costs you.

This page accompanies lesson 4 of the free video course "Double-entry bookkeeping, step by step". The amounts are examples, from the story of Anna's family, which we follow throughout the course: they're the same ones you see in the video.

Watch the lesson

The lesson lasts about nine minutes. Below you'll find the mortgage payment in three lines, the March income statement as a table, the calculation that reconciles the checking account with the profit and, at the end, the transcript.

$650 goes out, the cost is $150

On 10 March, $650 leaves Anna's checking account: the mortgage payment. If you ask her how much she spent in March, she counts all of it.

And yet the cost of that payment is $150. $150 is interest, the price Anna pays the bank for the money it lent her: that's a cost. The other $500 is principal, a piece of the loan being paid back. It leaves the account, but the debt goes down by the same amount.

Anna isn't $500 poorer: she owes $500 less.

The payment in three lines

Anna could record it as a single expense of $650. She chooses to split it into three lines.

$650 leaves the Checking account: it's an asset going down, so Credit 650. Where does it go? $150 goes to Mortgage interest, an expense account: an expense that grows goes on the Debit side. $500 goes to the Mortgage, which is a debt: a debt that goes down goes on the Debit side too.

10 March · mortgage payment

Total Debit 650, total Credit 650: the entry balances. Every transaction touches at least two accounts, and this one touches three.

Three numbers move together

Look at what changes with this one entry.

Anna's net worth, what she owns minus what she owes, has 650 less in money and 500 less in debt. In the end it goes down by $150: exactly the cost.

Where cost and payment part

So here's the rule, and where it stops. Paying back principal isn't a new cost: it changes the shape of your net worth, less money and less debt, but it doesn't shrink it.

A cost is what makes you poorer. A payment only tells you where the money comes from.

The snapshot and the film

The balance sheet from lesson 3 was a snapshot of 1 March: what Anna owns and what she owes, at a date. The income statement is the film: what made Anna richer and what made her poorer, from 1 to 31 March.

If you sail, the balance sheet is your position fix: the exact position of the boat on the chart, with the time written next to it. The income statement is the course the boat has sailed to get there.

The March income statement

On one side there's income: Anna's salary, $2,000, and Luca's, $1,500. $3,500 in all.

On the other side, the expenses: the supermarket, utilities, transport, restaurants, Luca's gym. And two lines people often forget: $150 of mortgage interest and $20 of interest on the car loan. $1,500 in all.

Anna's income statement, 1 to 31 March

Income minus expenses gives you the profit, which is how much richer Anna became during the month: $2,000. Accountants also call profit net income.

The principal paid back doesn't appear here. It isn't an expense: the Mortgage and the Car loan are debts, and they belong in the balance sheet.

The second puzzle: the account only goes up by $1,280

On 1 March, the checking account had $5,000 in it. On 31 March, it has $6,280: it's gone up by $1,280. But the profit is $2,000.

If Anna became $2,000 richer, where did the other $720 go?

$780 out, none of it a cost

You've just seen part of the answer: the $500 of mortgage principal. Then there's the car loan payment, on 15 March: $300, of which $20 is interest and $280 is principal.

15 March · car loan payment

500 plus 280 makes $780. That money left the account without being a cost: it lowered the debt, not Anna's wealth.

$60 of cost, not yet paid

The other part goes the opposite way. On 14 March, Anna and Luca go out for dinner and pay $60 by credit card.

14 March · dinner paid by credit card

The dinner is a March expense, because they had it in March. But the bank only takes the money on 15 April. So the cost counts against March's profit, while the money is still in the account. Instead of money going out, for now there's a debt on the card.

It all adds up

1,280 + 780 − 60 = 2,000. The checking account answers one question: how much money do I have? The income statement answers another: how much richer have I become? Double entry shows you the exact point where the two answers part ways.

When profit doesn't explain everything

In March, Anna's net worth goes from $97,200 to $99,200: it goes up by $2,000, exactly the profit.

Liabilities go down by $720: $500 less on the mortgage and $280 less on the car loan, $60 more on the card. It's the same 780 − 60 as before, seen from the net worth side.

It adds up because this month everything went through the income statement. It isn't always like that, and net worth isn't just the sum of the profits you've put aside. An account you already had but only record today, a change in an exchange rate, some revaluations recorded straight into equity: these change it by other routes. We'll see them in lessons 6 and 8.

Your turn

Same payment of 10 March, $650. Which lines go on the Debit side?

Try to answer before you read on.

There are two lines on the Debit side: Mortgage interest 150 and Mortgage 500. There's only one line on the Credit side: Checking account 650. If you'd put the mortgage on the Credit side, look at what kind of account it is. It's a debt, and it's going down.

The sentence to take away

What leaves your account tells you how you paid. The income statement tells you what it cost you.

For Anna's payment, 650 and 150.

How Cashfulness does it

In Cashfulness, the app I built to keep household accounts in double entry, the same things show up in three places. In the lesson you see them with the example amounts from Anna's family's story; in your own space they show your own figures.

• The Income statement page. This is the film. At the top, one sentence sums up the period, starting with "Year to date" and the year, then "you had a profit of" and the amount: in the lesson, $2,000. Below it, the income account by account (the app calls the section "Revenues"), then the expenses ("Costs"), with the Mortgage interest line, and the "Profit" at the bottom. You won't find the Mortgage here, and that's how it should be: it's a debt, and it belongs in the balance sheet. On a computer you get there from the sidebar, section "Balance", item "Income statement"; if you don't see it, switch from "Essential" to "Full" at the bottom of the sidebar.
• The Register. Open the "Mortgage payment" row of 10 March and you'll see the three lines with the Debit and Credit columns: Mortgage interest 150, Mortgage 500, Checking account 650, and the total underneath. One click on Mortgage takes you to the debt account: after that payment, the balance is $129,500. The bank, the debt and the cost, each in its place.
• The Mortgage or loan tool. Writing three lines once is easy. Doing it every month, with interest that changes with every payment, is the step people most often skip. You give the tool four numbers from the contract: the amount borrowed, the interest rate, the number of payments and the date of the first one. It works out the repayment schedule, and on each due date it proposes the payment already split between interest and principal. With a variable rate the schedule doesn't exist in advance: it's redone when the bank announces the new rate.

What is a general principle and what is a Cashfulness choice

General principles

• Every entry involves at least two accounts, and total Debit equals total Credit. The mortgage payment involves three.
• Expenses and assets grow on the Debit side; liabilities and income grow on the Credit side. Each goes down on the opposite side.
• Paying back principal reduces an asset and a liability by the same amount, and is not an expense. Interest, payment processing fees and penalties are expenses of the period.
• An expense belongs to the period in which you use something up, not the one in which you pay: the dinner on 14 March is a March expense even though the bank takes the money in April.
• The balance sheet is a snapshot of a date, the income statement tells the story of a period.
• Profit explains the changes in net worth that pass through the income statement. Opening balances recorded later, exchange differences and revaluations recorded directly in equity can change it by other routes.

Cashfulness's choices

• The sign: in the app, a Debit line has a positive sign and a Credit line a negative sign, so every balanced entry adds up to zero.
• The exchange difference on balances in a foreign currency stays out of the income statement. We'll see it in lesson 8.
• The Mortgage or loan tool proposes the payment on each due date already split between interest and principal, for you to confirm.

Choices of whoever keeps the accounts

• How many expense accounts to open and what to call them: here Mortgage interest is kept apart from Car loan interest, and Restaurants apart from Supermarket. Double entry doesn't prescribe it.

The amounts are examples and are there to isolate the mechanism. The payment has no processing fee, the salaries are take-home pay and taxes are not considered. Interest is recorded when the payment is made, which falls in the same month in which it accrues.

Frequently asked questions

Is the interest the only cost in a mortgage payment?

In Anna's payment, yes. A real payment can also carry a processing fee, and the contract may include charges or penalties: these are expenses of the period and go to an expense account, next to the interest. The principal doesn't.

Why doesn't my checking account balance match the month's profit?

Because they answer different questions. The account also goes down for payments that aren't expenses, like principal, and doesn't yet go down for expenses already incurred but paid later, like a credit card purchase that the bank collects the following month. Double entry makes each of these differences visible.

If I pay off part of my mortgage early, is that an expense?

The principal you pay back isn't: it reduces the account and the debt by the same amount. Only an early repayment fee or charge is an expense, if the contract includes one.

Transcript of the lesson

The text of lesson 4, lightly edited for reading. The numbers are the same as in the video.

On the 10th of March, 650 dollars leaves Anna's checking account: the mortgage payment. If you ask her how much she spent in March, she counts all of it. And yet the cost of that payment is 150 dollars. Separating what you pay from what it costs you is the job of the income statement.

Here's the short answer. 150 dollars is interest. That's the price Anna pays the bank for the money it lent her, and it's a cost. The other 500 is principal, a piece of the loan being paid back. It leaves the account, but the debt goes down by the same amount. Anna isn't 500 dollars poorer. She owes 500 dollars less.

Anna could record it as a single expense of 650. She chooses to split it into three lines. 650 dollars leaves the Checking account: Credit 650. Where does it go? 150 goes to Mortgage interest, an expense account. An expense that grows goes on the Debit side. 500 goes to the Mortgage, which is a debt. A debt that goes down goes on the Debit side too. Total Debit 650, total Credit 650. Every transaction touches at least two accounts. This one touches three.

Look at what changes. The checking account goes down by 650. The mortgage goes down by 500, from 130,000 to 129,500 dollars. March expenses go up by 150. And Anna's net worth, what she owns minus what she owes? She has 650 less in money, and 500 less in debt. In the end, her net worth goes down by 150. Exactly the cost.

So here's the rule, and where it stops. Paying back principal isn't a new cost. It changes the shape of your net worth: less money, and less debt. But it doesn't shrink it. Interest, on the other hand, is a cost. A processing fee on each payment can be a cost too, and so can a penalty. Anna's payment has none, but many real ones do. A cost is what makes you poorer. A payment only tells you where the money comes from.

Now let's step back and look at the whole month. The balance sheet from the last lesson was a snapshot of the 1st of March. The income statement is the film: what made Anna richer and what made her poorer, from the 1st to the 31st. If you sail, the balance sheet is your position fix. It's the exact position of the boat on the chart, with the time written next to it. The income statement is the course the boat has sailed to get there. On one side there's income. Anna's salary, 2,000 dollars, and Luca's, 1,500. 3,500 in all.

On the other side, the expenses: the supermarket, utilities, transport, restaurants, Luca's gym. And two lines people often forget: 150 of mortgage interest and 20 of interest on the car loan. 1,500 dollars in all. Income minus expenses gives you the profit, which is how much richer Anna became during the month: 2,000 dollars. The principal paid back doesn't appear here. It isn't an expense.

In Cashfulness, the app I built to keep household accounts in double entry, the film is the Income statement page. At the top, one sentence sums up the period: Anna had a profit of 2,000 dollars. Below it, the income account by account, then the expenses. Among the expenses there's the Mortgage interest line, 150. You won't find the Mortgage here, and that's how it should be. It's a debt, and it belongs in the balance sheet.

And here comes the second puzzle. On the 1st of March, the checking account had 5,000 dollars in it. On the 31st, it has 6,280. It's gone up by 1,280. But the profit is 2,000. If Anna became 2,000 dollars richer, where did the other 720 go?

You've just seen part of the answer: the 500 dollars of mortgage principal. Then there's the car loan payment, on the 15th of March. 300 dollars, of which 20 is interest and 280 is principal. 500 plus 280 makes 780 dollars. That money left the account without being a cost. It lowered the debt, not Anna's wealth.

The other part goes the opposite way. On the 14th of March, Anna and Luca go out for dinner and pay 60 dollars by credit card. The dinner is a March expense, because they had it in March. But the bank only takes the money on the 15th of April. So the cost counts against March's profit, while the money is still in the account. Instead of money going out, for now there's a debt on the card.

Let's put the pieces together. The account goes up by 1,280. Add the 780 of principal, which left without being a cost: 2,060. Take away the 60 for the dinner, a cost that hasn't left the account yet: 2,000. The profit. The checking account answers one question: how much money do I have? The income statement answers another: how much richer have I become? Double entry shows you the exact point where the two answers part ways.

One last point, because it matters. In March, Anna's net worth goes from 97,200 to 99,200 dollars. It goes up by 2,000, exactly the profit. It adds up because this month everything went through the income statement. It isn't always like that, and net worth isn't just the sum of the profits you've put aside. An account you already had, but only record today. A change in an exchange rate. Some revaluations recorded straight into equity. These change it by other routes. We'll see them in lessons 6 and 8.

In the app, you'll find the payment again in the Register. Open the row for the 10th of March. You'll see the three lines, with the Debit and Credit columns: Mortgage interest 150, Mortgage 500, Checking account 650. One click on Mortgage takes you to the debt account. After that payment, the balance is 129,500 dollars. The bank, the debt and the cost, each in its place.

Try it yourself, before the answer comes. Same payment, 650 dollars. Which lines go on the Debit side? Take a few seconds to think.

There are two lines on the Debit side. Mortgage interest 150, because an expense grows on the Debit side. And Mortgage 500, because a debt that goes down goes on the Debit side. There's only one line on the Credit side: Checking account 650. If you'd put the mortgage on the Credit side, look at what kind of account it is. It's a debt, and it's going down.

If you remember just one sentence, make it this one. What leaves your account tells you how you paid. The income statement tells you what it cost you. For Anna's payment, 650 and 150.

Writing three lines once is easy. Doing it every month, with interest that changes with every payment, is the step people most often skip. It's one of the reasons I built Cashfulness. There's a tool called Mortgage or loan. You give it four numbers from the contract: the amount borrowed, the interest rate, the number of payments and the date of the first one. The tool works out the repayment schedule. On each due date, it proposes the payment already split between interest and principal. With a variable rate, the schedule is redone when the rate changes.

Now you can tell a payment from a cost, and the film of the month from the snapshot. In the next lesson we go back to Anna's net worth, with a different lens. Her home, valued at 200,000 dollars, doesn't bring her a single dollar. Which assets work for her, and which ones are there for everyday life? Assets plus and Assets minus.

The previous lesson

Lesson 3 · Net worth: the number your bank balance doesn't show you. Anna has $5,000 in her checking account, but her net worth is $97,200. The snapshot of 1 March, account by account, with opening entries that balance.

The next lesson

Lesson 5 · Does the home you live in earn or cost? Assets+ and Assets−. Anna's home, valued at $200,000, doesn't bring her a single dollar. Which assets work for her, and which ones are there for everyday life? Lesson 5 looks at the same net worth with a different lens.

Try it on your own payment

If you have a mortgage or a loan, take the bank's repayment schedule and look at one payment: how much of it is principal and how much is interest. That's where you see the difference between paying and spending. Then redo the table of Anna's payment with your own two numbers: the lines on the Debit side must add up to the whole payment.

I built Cashfulness to keep household accounts in double entry. If you don't want to redo that split by hand every month, the Mortgage or loan tool works out the repayment schedule from four numbers in your contract and, on each due date, proposes the payment already split between interest and principal.

Discover Cashfulness

Sources

• IFRS Foundation (IASB), Conceptual Framework for Financial Reporting, chapter 4: income and expenses defined as changes in equity other than contributions from and distributions to holders of equity claims.
• Consumer Financial Protection Bureau (United States), How does paying down a mortgage work?: each monthly payment is split between principal and interest, and only the principal reduces the amount you owe.
• The examples come from the story of Anna's family, built for the course "Double-entry bookkeeping, step by step": every entry is checked, with total Debit equal to total Credit.

Vittorio Giusti is an economist and psychologist, and he built Cashfulness.