Banker’s Terms: What is the Principal?

The fact that you are thinking about going to the bank means you are considering a loan. You would like to have some money lent to you and in return you will agree to pay back the loan subject to certain terms.

Isn’t the Principal the Amount I Borrow?

Most times this is true, take out a $100,000 loan, and the principal is $100,000 (at least until you start paying it back). This isn’t always true, though. Some loans specify that they will lend you $99,000 at the start, but you will instantly owe $100,000. The loan was 99k but the principal is 100k.

The Principal

The Principal is not simply what the borrower owes. Principal is the current amount the borrower owes to the lender irrespective of interest. In an amortized loan, each payment will pay off the accrued interest as well as a small part of the principal. If the borrower calls the bank and asks for the balance of the loan, the teller will tell them the principal, or amount needed to pay off the loan if paid today. Whatever interest accrued after the most recent payment will need to be paid as well in order to close out the loan. Additionally, any late fees or other fees will need to be paid.

Payments

When making a payment on a loan, the lender will typically apply the payment to any fees and interest due first, then use the remainder to pay the principal. Some will even hold the amount in an account until the next payment comes due. This is nice for the bank, which gets to continue accruing interest on the principal. It’s always a good practice to specify that you want the payment to go toward the principal whenever possible. This decreases the principal and the amount of interest paid over the life of the loan. Just be sure you have enough money to keep making the payments.

Dr. Equity

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