Loan Principal Definition and Basics

A loan principal is the original amount of money you borrow. It’s separate from the interest you pay. That amount is the cost you pay to a lender for letting you borrow money. Understanding how to calculate principal and interest is key so you know how much you could pay overall over the life of the loan. There are also costs to consider as well.

What Is a Loan Principal?

A loan principal is the initial amount of your mortgage loan, not including any interest or fees. This amount is used to calculate your interest and any fees you may need to pay, like closing costs.

What Is Principal vs. Principle?

In finance terms, principal is the original amount you borrowed from a lender, whereas the term principle has nothing to do with money. Instead, the word has to do with beliefs, morals or rules.

The term principal can also refer to other areas in finance, including the face value of bonds and the leader of a company working in legal contracts.

Initial vs. Outstanding Principal

Although your principal is the original amount you borrow on a mortgage, it can also refer to the amount you continue to owe as you make payments.

In other words, the initial principal is the amount you initially borrowed and the lender uses this amount to determine the interest you’ll pay and monthly repayments. The outstanding principal, then, is the amount you still owe after paying down the original principal each month.

For example, you borrow $350,000 — this is your initial principal. Over a few years of payments, the amount is reduced to $275,000, which is now your outstanding principal.

What Is Your Principal Payment?

Your principal payment is a payment towards lowering your actual loan balance. You can calculate your mortgage loan principal by subtracting your down payment from your home’s final price.

Say you purchase a home for $350,000 and you decide you put 20% down. That means you’ll need to put down $70,000. The lender will loan you the difference — $280,000 — your principal loan balance.

Part of your monthly mortgage payments goes towards the principal. The remainder goes towards the interest and an escrow account (for property taxes and homeowners insurance) if you have one.

Amortization Schedule and Your Principal Payment

An amortization schedule refers to a process in which you pay down your principal and interest over the life of your loan, which is typically anywhere from 15 to 30 years for a mortgage. Lenders will use what’s known as an amortization schedule to show you how much of your payment goes towards the principal and interest. Initially, you may pay more in interest. Gradually, you’ll pay more towards the loan principal when you get closer to the end of the repayment period.

What Is Interest?

Interest is money you pay your mortgage lender in exchange for taking out a loan. Most lenders determine your mortgage rate as an annual percentage rate (APR).

APR is the total cost you pay on your loan per year, which includes interest and fees you pay towards your mortgage. These fees can include origination or application fees, and even other charges you need to pay to close your loan.

Loan Principal and Interest Rates

The interest rate on your loan depends on a number of factors, some of which may be in your control:

• Current economic conditions
• Your credit score
• Your Income
• Your down payment amount
• Your home’s location

For instance, you have an excellent credit score and your lender offers you $350,000 for a 30-year loan with a 5% interest rate. Meanwhile, the same lender offers the same loan to someone with a lower credit score, but with a 6% interest rate.

In this case, you’ll pay a total of $326,395 in interest. The borrower with the 6% interest rate ends up paying $546,938. Here, a 1% difference means an extra $220,453 in interest charges.

Even Principal and Even Total Payments

Although it’s common to see an amortization schedule with more going towards interest, you may find some loans that are set up as having fixed or even principal payments.

With even principal payments, the amount you pay going towards the principal each month is the say. So if you took out a 15-year mortgage, a lender could determine your principal payment to be $600 each month. The interest is based on your outstanding balance at the end of each repayment period. That means the interest you pay goes down the more payments you make because your principal also goes down.

What Else Is Included In Your Monthly Payment?

Although interest and principal make up the bulk of a mortgage payment, your monthly payment also includes other charges — namely property taxes and homeowners insurance, also known as PITI.

Here’s a breakdown of what your mortgage payment could be:

• Property taxes: The amount you pay in property taxes will depend on where you live and the value of your home. 
• Homeowner’s insurance: Most mortgage lenders require you to have homeowners insurance as a requirement for borrowing money.

Your lender will hold the money you owe in property taxes and insurance premiums in an escrow account. You’ll make a payment each month, with the amount paid out to your insurance provider and local tax collector. The specific amount you’ll pay depends on your property tax rate and insurance costs. 

Property Taxes

Property taxes can be a huge cost to home ownership and are an important funding for your local area, such as public schools, fire departments and road repairs.

The amount you pay in property taxes may go up each year. Your local tax collector should provide information to you each year about what your proposed amount will be.

Homeowners Insurance

Homeowners insurance protects your home against covered disasters like theft, fire and certain types of natural disasters. Like property taxes, factors like your home’s location and value play a big part in how much you could pay. How many claims you made in the past and any additional features of the home (like a pool) could also affect your insurance premiums.

Will My Principal or Interest Ever Change?

With fixed-rate mortgages, your payment will be the same amount each month for your loan principal and interest until you pay off your loan. The overall payment may change if your property taxes or homeowners insurance premiums go up or down.

Your monthly payment will likely change if you choose an adjustable-rate mortgage (ARM). If you make extra payments or want to pay off your loan early, the interest you pay could be different.

Adjustable-Rate Mortgage (ARM)

An ARM is a type of mortgage where your interest rate changes over time and is based on current economic conditions. Usually, lenders offer a low introductory interest rate with an ARM for a fixed period of time. Afterwards, your rate could fluctuate each year. This type of loan could cost you more in interest.

Paying Ahead on Your Mortgage

Paying even a little extra money each month on your principal can save you a lot of money over your loan repayment term. Depending on how much extra you pay each month over a period of time, you may be able to pay your mortgage off in less time than your repayment term allows for.  

With a $350,000 loan with a 6% interest rate and a 30-year term, for example, your monthly payment could be around $2,098 per month, not including property taxes and homeowners insurance.

Paying an extra $100 a month would reduce the amount of interest over the course of your loan by nearly $54,694. Doing so also means you may be able to pay off your loan three years and five earlier.

The Bottom Line: Keep Track of Loan Principal and Interest

Keeping track of your monthly mortgage payments — including your loan principal and interest — will help you to budget each month for on-time payments. It can also help you to see whether you want and can afford to make extra payments towards the principal to save on interest cost.