Principal (Finance)

Definition

The term principal can have several meanings. It can refer to the remaining balance on a mortgage or loan, the owner of a privately owned company, or even the par value of a bond.  When the term principal is used in this publication, it's often referencing the outstanding balance on a loan.

Explanation

When making a monthly mortgage or loan payment, a portion of the money is directed towards paying down the principal, in addition to the interest charges for use of the money.  In the early stages of a mortgage, a larger proportion of the monthly payment is used to pay for interest charges.  Over the life of the loan, a larger proportion is directed to reducing the outstanding principal.

Several of the loan calculators appearing on this website demonstrate this point.

Example

A 30 year loan of $100,000 at 6% interest rate would require a monthly payment of $599.55.  In the first month, $500.00 of the payment is used to pay the interest expense, and $99.55 is used to pay down the principal.

In the 25th year of the loan, the monthly payment is still $599.55; however, with an outstanding principal balance of only $31,000 on the loan, $442.28 of the payment goes towards principal pay down, and only $157.27 is needed to pay the interest expense.

Related Terms

mortgage, interest charges, par value, simple interest, compound interest, annual percentage rate, effective interest rate or yield