What is a loan principal?

what-is-a-loan-principalImage: what-is-a-loan-principal

In a Nutshell

When you take out a loan, your payments are primarily broken up into two parts — principal and interest. The loan principal is the amount you borrow and goes down as you begin to pay it back, while interest is the cost of borrowing the money.
Editorial Note: Credit Karma receives compensation from third-party advertisers, but that doesn’t affect our editors’ opinions. Our marketing partners don’t review, approve or endorse our editorial content. It’s accurate to the best of our knowledge when posted.
Advertiser Disclosure

We think it's important for you to understand how we make money. It's pretty simple, actually. The offers for financial products you see on our platform come from companies who pay us. The money we make helps us give you access to free credit scores and reports and helps us create our other great tools and educational materials.

Compensation may factor into how and where products appear on our platform (and in what order). But since we generally make money when you find an offer you like and get, we try to show you offers we think are a good match for you. That's why we provide features like your Approval Odds and savings estimates.

Of course, the offers on our platform don't represent all financial products out there, but our goal is to show you as many great options as we can.

When you take out a loan, your payments are primarily broken up to pay for two main portions of the loan — the principal and the interest.

Think of the principal as the money you borrowed from the lender. The interest is the amount it’ll cost you to borrow that money. Both amounts go down as you make payments over the life of the loan.

Loan principal vs. interest

If a loan principal is determined by the amount you’ve borrowed, then the interest you pay back on the loan is considered to be the cost of borrowing that money.

Your original interest payments will often be structured as a percentage of the principal. The annual percentage rate (or APR) you get depends on both the lender’s policies and your creditworthiness — the higher your credit scores and the stronger your credit history, the more likely it is that you’ll receive a lower interest rate.

Read more: What is APR and why is it important?

How is the principal paid back?

When you start to pay off a large loan, most of the minimum monthly payment you make will be on the interest, and then some will go toward your principal. That’s because the higher your principal, the higher the interest — and interest owed gets paid first.

Your monthly payments can stay about the same (as long as you pay at least your minimums on schedule), but how much of your payment is allocated to each portion will change over time. As your payments continue, you’ll slowly start to pay more in principal and less in interest — the lower your principal, the less interest grows.

Some loans allow for “principal-only” payments. These are usually extra monthly payments on top of your minimum amount. You can set up your monthly payments as usual and then make an additional payment to go toward just your principal.

Some lenders require notice if you want an additional payment to be applied only to the principal instead (and not interest). Not every lender offers principal-only payment options, so make sure you check with yours before sending that extra check.

There may be a way to structure your payments to pay all of your interest first, too. But it might not be the best idea. Your interest wouldn’t decrease since you wouldn’t be paying down the principal.

How to identify your loan principal

Your loan’s monthly statement will usually show you a breakdown of how much money you owe toward your principal balance and how much you owe toward any interest or fees.

For instance, the U.S. Department of Education shows that your student loan account statement can be broken down by interest rate, monthly payments, daily interest (the interest that gets added to your loan daily), and principal balance.

You can also see your loan principal on your mortgage statement. The U.S. Department of Housing and Urban Development has a monthly mortgage statement example, which shows how you might see how much of your loan payment goes toward interest and how much goes toward the principal balance.

If you have trouble determining where your payments are going, contact your lender for more information.

About the author: Dori Zinn is a personal finance journalist based in Fort Lauderdale, Florida. She enjoys helping people find ways to better manage their money. Her work can be found on numerous websites, including Bankrate, FinanceBu… Read more.