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What Is the Principal of a Loan?

Back to questions list October 8, 2020

When you need extra money to cover your expenses or fund something, you will probably apply for a loan. No matter what type of loan you take, a small personal loan or a business loan, the payments will be divided into two main parts. One part of your payments is called a loan principal and the other one is the interest itself.

The principal amount of loan is the initial amount of money you borrow, while the interest is the cost of taking this money.
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What Is the Loan Principal?

Let’s start with the loan principal definition. The word “principal” relates to your investments, mortgages, or loans and it means “main”. In other words, the principal on a loan is the main or most significant part of your total debt.

This term may be also used for:

  • Defining the balance on the principal loan account at a particular time after the borrower made the last payment.
  • Talking about the initial amount of money the borrower has taken.
  • Determining the investment in a business or personal assets, such as equipment, building, or a car.

Principal Loan Balance for Investments

Investments are similar to the common loans in the fact that they also have principal and interest parts. However, interest is the opposite. The major part of the investment is the principal amount, which is the amount of money you’ve invested.

Many potential borrowers want to know how much is the principal on that loan. Pay attention to the details of the loan before you sign any documents and use a loan principal calculator if you want to be aware of the numbers.

Loan Principal Payment vs. Interest

We’ve already talked about what is the principal of a loan. There is a difference between principal and interest. The interest payments (or the APR) will usually depend on the creditworthiness of the borrower and the policy of the lender. The better your credit history is and the higher the credit score you have the lower interest rates you can get with the loan.

So, financial experts often suggest improving your credit score first before you apply for personal loans. This will increase the chances of being approved for a loan principal payment with the best rates.

How Is the Principal Amount of an Interest-Only Loan Repaid?

At the beginning of the repayment period, the borrower will make the bigger payments towards the interest and the smaller part will go towards repaying the principal. This happens because first, you need to pay the interest off, as it is higher when the principal is higher. You need to pay the minimum amount on a monthly basis, and the payments may remain about the same. Later on, the principal and the interest parts will change places, so that you pay less interest and more principal.

Some people decide that paying all of the interest may help them repay the debt faster. In reality, this idea isn’t worth trying as the interest won’t lower because the principal part won’t be repaid first.