What Is The Principal Of A Loan?
Find out the basics of getting a loan and repaying it, with a real-life example and the math involved in it.
Let’s assume you have a big expense coming your way: a house downpayment, your kid’s college fees or even a car that you want to buy. And let’s be honest, no one, including you, has a couple thousand dollars just lying around to make that kind of a payment. That is when you realize you probably need a loan to fund those expenses.
When you’re taking a loan, the lender gives you a repayment plan. The two major components of repaying the loan are the principal amount and the interest rate with it.
Loan Principal Definition
The principal of a loan is simply the amount you were originally given which is due EXCLUDING the interest. After the interest is added, the loan to be repaid increases. The principal amount is the one you were originally given as a loan.
These are the various definitions of loan principals:
| Different Types of Principal | Definition |
| Loans | The sum of money borrowed |
| Investments | The amount of money put into an investment |
| Bonds | The face value of a bond |
| Companies | The owner of a private company, partnership, or other type of firm |
| Transactions | The party that has the power to transact on behalf of an organization or account and takes on the attendant risk, whether it be an individual, a corporation, a partnership, a government agency, or a nonprofit organization. |
Note: These definitions have been extracted online, courtesy of Investopedia.
What is a Principal Payment?
A principal payment is basically paying back the loan that you originally borrowed. As you pay back, over time the principal amount decreases. You still keep paying the interest amount which is the cost of borrowing the money.
A principal payment is made in a partial plan or a full repayment plan. A partial plan allows borrowers to pay the minimum amount due each month. A full principal payment is a plan where the entire amount is paid upfront, ending the loan early.
Understanding Principal Loan Repayments with a Real-Life Example
Charles runs an interior design business and wants to establish his own office. He needs funds for both rent and equipment. To cover these expenses, he takes out a $10,000 loan from a commercial bank with a 4% annual interest rate.
As he repays, he splits each payment between the loan’s principal and the interest. For instance, with a $500 monthly payment, $33 goes toward interest, while the remaining $467 reduces his principal.
After this payment, his new loan balance stands at $9,533. This straightforward breakdown shows how principal payments work in practice.
Loan Principal Calculator
Whenever you’re given a loan, you should be sure as to how you will plan on paying it back. Having this kind of financial planning is very important when it comes to loans and repayments. To do this, you need to have an estimate of how much loan you’re going to be able to pay back each month.
For this, there are several Loan Principal Calculators online that help you get an estimated figure. All you have to do is enter some figures like loan amount, duration of the loan, interest rate agreed upon etc and you will know approximately how much you can expect to pay each month.
What is Principal Balance on a Car Loan?
When you borrow a loan for the purchase of your car, any outstanding dues will be applied first. Then, the remaining money will be liable on any interest including outstanding interests as well. Everything left on your payment will eventually be applied to the principal balance of your loan.
If you have any further questions, it is best that you contact your lender and ask them for more guidance regarding the subject.
A Quick Recap
The foundation of borrowing starts with the principal amount and interest rate, with other complexities added later. The principal is the initial loan amount you owe, while the interest rate applies on top of it. As you make monthly payments, including both principal and interest, your debt gradually decreases.
Paying more toward the principal in the early years can shorten your loan term, saving you money on interest. This strategy could significantly reduce the time you’re tied to the loan.
Conduct your own research to fully understand the loan and market dynamics. Consistently make timely payments to protect your credit score, as missed payments can lower it.
