What is a loan principal?
A loan principal is the amount of money you’re borrowing from the bank. It is only one part of your monthly loan payment andexcludes any interest or additional fees you owe to the bank. For example, if you borrowed $100,000 for your business, your loan principal is $100,000.
You need to eventually pay back that total balance along with any interest you accumulate during the life of your loan. As you make payments, your principal balance gets smaller. For instance, if you paid off $20,000 of your $100,000 principal, the new principal balance would be $80,000.
Related:COVID-19: Loans and Additional Funding for Small Businesses
The difference between principal vs. interest
Loan payments are made up of your principal and interest. The principal is the main part of what you owe. Banks charge an additional interest so they can make money on the loan. Essentially, the interest is what you pay for the time you are borrowing the money. The longer it takes you to pay off your loan, the more interest you will accumulate.
Kinds of principal payments
These are the different ways you can pay off your principal:
- Amortized payments: This is the process of using fixed payments to spread out your loan. Your payment amount stays the same each month, but the funds go toward different parts of the loan. For example, as you pay off more of your principal, you may have less interest to pay later on.
- Even-principal payments: The monthly amount you pay toward your principal balance is the same throughout the entirety of your loan payment schedule. Your interest payment will change as it depends on the remaining principal you owe. As you owe less principal, your interest payments lower as well.
- Even total payments:This is when your monthly payments stay the same, but the amount of it that goes toward your principal and interest changes over time. As you pay off your interest, more of your monthly payment goes toward paying off your principal.
- Interest-only loans:This is when you pay only the interest for the first few years of your loan term. After this initial period, the interest rate may change, and you start paying off your principal.
- Principal payment:This is when you only pay off the principal and not the interest. This strategy can help you lower your overall accrual of interest.
Here are common questions about the topic of loan principals:
