Loan Principal

Loan Principal Definition and Meaning

Loan principal is the amount of money you borrow from a lender. As you pay off a loan, your principal decreases. Principal is only one factor that determines your monthly loan payments. The other factors are the interest rate and length of repayment, also called your loan term.

Comprehensive Breakdown of Loan Principal

Your loan principal is the base amount you ask a lender to borrow. If you're buying a $250,000 home and making a $50,000 down payment, your loan principal is $200,000.

With most loans, your payment is applied first to the interest you owe, and the rest goes toward paying down your loan balance. With each payment, the amount of principal you owe decreases until it eventually reaches zero. This process is called amortization. Each month, your principal balance becomes a little smaller, so the interest you owe falls slightly. And that means every month, less of your payment is needed for interest and more of it goes toward paying down your balance. Here's an example illustrating a two-year personal loan's amortization.

What commonly happens is that in the early stages of paying off a loan, most of your payment  goes toward the interest portion, leaving little for the principal. But with each payment, less is required for interest and more goes toward reducing the balance. In the later stages of your loan, you'll find that more of your monthly payments will go toward the principal and less toward the interest. 

If you decide to make extra loan payments toward your principal, you can repay your debt faster and spend less money on interest (though you'll need to be careful, because some types of loans come with a prepayment penalty).

Types of Loan Principal

When you first borrow money, that sum is called your initial principal. It represents the total balance of your loan the day you sign it.

As you make loan payments, your principal decreases. The remaining principal is called your outstanding principal. 

Example of Loan Principal

If you take out a $200,000 mortgage at a 7% fixed interest rate with a 30-year repayment period, your monthly payments will be about $1,330. But the entire $1,330 won't go toward principal.

Your first month, roughly $164 of that payment will go toward principal with the rest going to interest. During your last month, almost the entire $1,330 will go toward principal with just a few dollars going to interest.