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.

An Example

Let me give you a real-life example to make principal loans and payments easier to understand.

Charles has an interior designing business and is looking to set up his own office space. He requires money to rent the place and equipment too. He obtains a loan of $10,000 from a commercial bank on an annual interest rate of 4%.

Upon repayment, he has to pay a portion of the principal amount of $10,000 along with an interest rate of 4% on the amount. Suppose he makes a monthly payment of $500. Amongst this $500, $33 will go in payment of the interest rate and the remaining $467 will go in the reduction of the principal amount.

After making this payment, his loan principal is now $9,533. This is basically the math of how the principal payment process works.

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 world of borrowing starts from the basic area of principal amount and interests; all other things are added later on which make it more complicated. The loan you get (the amount agreed on) is the principal amount you owe, and the interest rate is then added to the principal amount. Where the interest has to be paid each month along with the principal amount, it decreases as you make payments.

If you pay a larger sum of principal in the initial years, you could actually end the loan earlier than the expected duration. This could be very helpful for you as you won’t have to keep paying for the loan.

You should do a little bit of research yourself so that you’re absolutely sure about how the market and loans work. Just make sure you’re always paying back the loans promptly so that you never miss a payment, otherwise your credit ranking could really decrease.

Nabeel Ahmad

Nabeel Ahmad

Nabeel Ahmad is the founder and editor-in-chief of Insurance Noon. Apart from Insurance Noon, he is a serial entrepreneur, and has founded multiple successful companies in different industries.

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