Principal
Principal is the original amount borrowed on a loan. Learn how principal decreases with payments and affects interest costs.
Definition
Principal is the amount of money borrowed on a loan before interest and fees. In a mortgage, the principal is the loan balance used to purchase the property. Monthly payments reduce the principal over time, gradually building equity. Interest is calculated on the outstanding principal, so larger payments toward principal reduce future interest costs. Borrowers can make extra principal payments to pay off loans faster and save money. Understanding the distinction between principal and interest helps borrowers interpret amortization schedules and assess loan affordability.
Why It Matters
For the first several years of a 30-year loan, almost nothing you pay reduces what you owe. On a $500,000 mortgage at 6.5 percent, the opening payment sends about $2,708 to interest and only $452 to principal. That is why sellers who bought two years ago often find, after commission and closing costs, that there is less equity than they assumed.
Examples
Adding $300 a month toward principal on a $450,000 loan at 6.75 percent removes roughly seven years and $170,000 of interest.
A homeowner sells three years into a $400,000 loan with a balance still near $385,000, so a $430,000 sale price leaves very little once closing costs are paid.
One extra $6,000 principal payment in year two saves considerably more interest than the identical $6,000 in year twenty, because early interest accrues on a much larger balance.
Tips
Write apply to principal on any extra payment, then verify it in the servicer's transaction history next month. Many servicers default extra money toward the next installment or park it in suspense.
Pull an amortization schedule and find the month where principal first exceeds interest. On most 30-year loans at current rates it falls past year 18, which reframes what a 5-year hold really builds.
Weigh a recast against simply paying extra principal. Recasting lowers the payment while keeping the same payoff date, whereas extra principal shortens the term and saves more total interest.
Related Terms
Amortization
Amortization spreads out loan repayment over time. Explore how principal and interest are allocated ...
Negative Amortization
Negative amortization occurs when monthly payments don’t cover interest, increasing the loan balance...
Equity
Equity is the difference between a home’s market value and the mortgage balance. Learn how equity gr...
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