Principal

The principal is the original amount of money borrowed in a loan agreement, before interest and fees. When a loan is repaid on a capital-and-interest (repayment) basis, each monthly payment comprises a portion of principal and a portion of interest. Early in the loan term, more of each payment goes to interest; as the principal reduces, the interest component falls and more goes to capital repayment.

Understanding the distinction between principal and interest is important when evaluating loan costs. A lender might quote a flat rate (interest charged on the full principal throughout the term) rather than an APR (which reflects the reducing balance). A flat rate of 5% on a 3-year loan is equivalent to an APR of approximately 9%, because the principal reduces over time but interest is calculated on the original amount.

For early repayment, the outstanding principal is the amount that must be repaid, plus any applicable early repayment charges and accrued interest. Lenders provide redemption statements showing the exact amount required to clear a loan on a given date.

Related terms