Principal

Before you rely on it

What to check

Check that an extra payment is applied to principal.

The common error

Where people go wrong with principal

Sending extra money that gets held as a prepayment of next month's scheduled payment. The balance does not move, no interest is saved, and the borrower thinks they are ahead.

Worked through

Principal in plain numbers

You borrow $10,000 at 6% for five years, with a monthly payment of $193.33. In the first month, interest is $10,000 × 0.005, or $50. So $143.33 of your payment reduces the principal, and the balance becomes $9,856.67. Next month interest is charged on that smaller amount, $49.28, and $144.05 goes to principal; the principal shrinks a little faster each month. On the investing side, the same word means the amount you put in before growth. Deposit $10,000 and earn $500, and your principal is still $10,000.

Easily confused

Principal and its neighbours

Principal is not interest, and it is not the payment. Interest is the cost of using the money. The payment is the amount you send, split between the two. Principal is the amount borrowed or invested, or what remains owed, and the word also appears in other senses: a principal in a business is an owner or lead party, and a school principal is a head teacher. In finance the spelling with pal is standard, and it should not be confused with principle. Outstanding principal is the balance still due.

In real decisions

Where principal turns up

Loan statements list principal balance, and amortization schedules show how it declines. Extra payments applied to principal shorten a loan and cut total interest; investors track principal separately from gains. Bonds repay principal at maturity. Tax reporting separates interest income from return of principal. When you check a payoff quote, the principal is the largest part.

Know the edges

Where principal stops being reliable

Principal balance and payoff amount can differ by accrued interest and fees; some loans, such as negative amortization loans, let the balance grow. Investment principal can lose value. Statements sometimes label extra amounts in ways that are hard to follow, and read your statement to see how each payment is applied, and ask the servicer to apply extra money to principal in writing.

Quick answers

What people ask about principal

What is the difference between principal and balance? On a simple loan, the principal balance is what you still owe before interest. The payoff balance may add accrued interest and fees. Ask for a payoff statement to close a loan.

Do extra payments go to principal? Only if instructed. Some servicers apply them to future installments. Specify principal-only in writing.

Is the principal on an investment safe? Not always. Deposits at insured banks are protected within limits, while market investments can lose part of their principal.

What is a principal-only payment? A payment designated to reduce the loan balance directly, without covering interest or fees. It shortens the loan and lowers total interest.

How does principal differ from a deposit? Both start a balance. Principal on a loan is what you owe. Principal on savings is what you put in. In both cases interest is calculated from it.