What is a Loan Principal?

//What is a Loan Principal?
What is a Loan Principal? 2017-10-09T06:21:46+00:00

Definition: A principal is the total amount borrowed from a lender. In other words, it is the amount of debt outstanding in at any given point of a loan.

What Does Principal Mean?

What is the definition of principal? Principal is a commonly used term in business. In practice, it refers to the amount of debt outstanding at a certain moment. This amount is used to calculate interest expenses for the period. Keep in mind that interest expenses, either accrued or accumulated, are not part of the outstanding balance unless the loan is compounded.

In a regular loan, the outstanding balance amount will change after each payment is made. The total loan payment is typically made up of two parts: principal and interest. As the principal payments are applied to the loan balance, the outstanding loan amount owed is reduced.

From the perspective of the bank, the principal is the amount loaned to the customer and after each payment is received the bank will calculate what the current outstanding balance is. In some cases, as is the case with bonds, interest is paid periodically, but the principal of the bond is paid when the bond maturity date is reached.

Here’s a brief example.

Example

Big Body Fitness Co. is a gym located in the downtown area of the city of Phoenix. This company took a 24-month loan of $250,000 last month to fund its current expansion plans. The company’s CEO, Mr. Jones, asked his accountant how much he will owe after the first $10,856.23 monthly payment is made. The bank charges an interest rate of 4 percent. What will be the outstanding balance owed by Big Body Fitness after the first payment.

As of now, the current principal is $250,000. This means that for the first month the interest expense will $250,000 x 0.33333% (which is the monthly interest rate or .04 / 12). The result is $833.33; this would be the interest expense for the first month. Thus, $10,022.90 of principal is paid off in the first month ($10,856.23 total loan payment – $833.33 interest expense). This means the company will owe the bank $239,977.10 after the first payment is made.

Summary Definition

Define Principal: Principal means the amount borrowed and still owed to a lender.