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Principal
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Principal

The balance on a loan. Monthly interest due is calculated by multiplying the principal balance by the monthly interest rate. When a monthly payment exceeds the interest due, the excess is applied to the principal balance, which reduces it.

More On Principal

Definition

The balance on a loan. Monthly interest due is calculated by multiplying the principal balance by the monthly interest rate. When a monthly payment exceeds the interest due, the excess is applied to the principal balance, which reduces it. The faster a borrower repays the principal, the less interest expense will be accrued over the loan’s lifetime.

Principal Explained

When you first take out a loan, the principal is the original amount you borrowed. As you pay toward that debt, the principal becomes the outstanding balance on the loan, not including interest and any fees accrued.

Depending on the type of loan you have, your payments will include money for both principal and interest. (Interest-only mortgage loans are one exception.) With most fixed-rate mortgages, the majority of your payment will go toward interest rather than principal in the first few years. Your mortgage statement will show how much principal remains on the loan.

The good news is that, unlike payments toward principal, the interest on your mortgage loan is generally tax-deductible. So, higher interest payments can mean a bigger tax refund. This tax benefit generally shrinks over the life of the loan, depending on the type of mortgage you have.

The amount of principal that you have paid off represents the equity you have in your home, assuming the market value is close to what it was when you bought the house. As you build equity, you are able to use that investment as collateral for low-cost home equity loans or home equity lines of credit.

Some lenders allow you to pay the principal payments more quickly by using an accelerated payment schedule, or even by including a few extra dollars earmarked for principal in your regular loan payments. Some lenders charge a prepayment penalty, though, so be sure you understand your options before making any decisions.