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.
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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.
Frequently asked questions about loan principal
Here are common questions about the topic of loan principals:
How do you calculate the principal on a loan?
The principal is simply the total amount of money you borrowed and must pay back. Calculating the principal you owe is as simple as subtracting the principal payments you have already made from the total principal balance. For example, if you borrowed $10,000 and have paid $1,000 toward your principal for each of the past three months, your current principalbalance is $7,000.
$1,000 (principal payment) x 3 (number of payments) = $3,000 (principal paid off)
$10,000 (original principal balance) – $3,000 (principal paid off) = $7,000 (current principal balance)
Is the principal on a loan tax deductible?
You may not deduct what you pay toward the principal since it is not considered income for the business. This is because the IRS only sees this as money you owe, not anything that you earned. When you pay interest on your loan, you can claim this as a business expense on your tax return.
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How can I pay down my small business loan faster?
Paying off your principal can lower the amount of interest your loan accrues over time, which can save you quite a bit of money on your loan. Create a business budget where you have plenty of money set aside to aggressively pay off your loan. You may need to find ways to both lower your business spending and increase your revenue. Stay consistent with your budget so you can pay your loan off within your ideal timeframe.
