What is a Loan Principal?

//What is a Loan Principal?
What is a Loan Principal? 2017-10-05T06:35:07+00:00

Definition: A loan principal is the amount the borrower agrees to pay the lender when the loan becomes due, not including interest. In other words, this is the amount the borrower owes the lender, not including interest, at any given point in time during the life of the note.

What Does Loan Principal Mean?

What is the definition of loan principal? A note payable or promissory note is a loan give to the maker, borrower, by the payee, lender. This type of loan must be in writing and contain specific payment terms including a payment schedule, maturity date, and interest or implied interest rate. The principal balance of the note equals the original amount borrowed less any principal payments made.

It’s important to notice that interest is not considered when calculating the principal portion. Interest expense is a separate expense that does not affect the carrying balance of the note. The note does, however, use the outstanding principal balance to calculate the interest expense for the period. Let’s take a look at an example.

Example

Dave’s Guitar Shop is expanding its operations and just secured a promissory note from a bank to finance the addition. The 10-year $50,000 loan must be paid in equal annual payments with an interest rate of 10 percent.

On the day Dave receives the loan, his principal balance is $50,000. This is the amount that he owes the bank. At the end of the first year, Dave makes his first payment of $8,150. Most of this payment doesn’t go to the principal balance. Instead, it goes to pay the 10 percent interest expense on the principal. Dave would record his first loan payment by debiting the note payable account for $3,150, debiting the interest expense account for $5,000, and crediting cash for the full $8,150 payment amount.

After the first payment is made, Dave’s principal note balance will be $46,850 ($50,000 – $3,150).

Summary Definition

Define Loan Principal: Principal balance of a loan means the outstanding balance that the borrower owes the lender.