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What is a Principal on a Loan?

What is a Principal on a Loan?

The principal of a loan is the amount of money borrowed before interest is applied. Essentially, it is the cost of the item, and the amount owed decreases with each payment.

The principal might help a borrower cover the full financial need of a particular situation, such as covering an emergency expense, or it might provide some financial relief when combined with the borrower’s savings. It is typically the amount someone seeks out to borrow before they know anything about the lender’s terms.

For example, Jay decides to take out a small installment loan of $650 in order to improve his credit. He has made mistakes in the past with his money and wants to make it right by using a small loan and consistent payments towards it to show the credit bureaus he has turned over a new leaf.

The amount he will actually pay depends on the interest rate he qualifies for, as well as whether or not that interest rate is a fixed rate or a variable rate.

Jay’s monthly payment will go both towards the $650 and the interest rate, meaning his total payment will be more than the $650. However, Jay sees this as a worthy endeavor in order to improve his chances of qualifying for better loans in the future, such as a car or house loan. He is building a positive credit history of consistency, timely payments on both the principal and interest of his small installment loan so that he is more likely to qualify for larger, lower interest loans in the future.

Financial Terms and Definitions