Loan Principal Amount

Updated on March 19, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Loan Principal Amount Definition

The Loan Principal Amount refers to the amount that is actually given as the loan from the lender of the money to its borrower, and for instance, a home loan principal amount is the amount on which the interest is charged by the lender of the money from the borrower for the use of its money.

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It is to be noted that the outstanding loan amount does not include the interest that is being charged on the principal loan amount. However, the lender uses the outstanding amount to calculate the interest expense for the period. In short, this principle is the amount that the borrower owes to the lender, not including interest, at any point in time during the life of the loan.

Loan Principal Amount Explained

The loan principal amount represents the initial sum of money borrowed by an individual or a business from a lender. This amount is the core component of a loan and serves as the foundation for calculating interest and determining the overall cost of borrowing. Understanding the loan principal is essential for both borrowers and lenders, as it directly influences the terms and conditions of the loan agreement.

When a borrower obtains a loan, the principal is the total amount disbursed by the lender. For example, if a business secures a loan of $50,000, the principal is $50,000. The borrower is obligated to repay this principal amount over the agreed-upon period, along with any interest charges.

Interest is calculated based on the outstanding loan principal. It represents the cost of borrowing and is typically expressed as an annual percentage rate (APR). As the borrower makes payments, a portion goes toward reducing the principal, and the remainder covers interest charges.

The loan principal amount calculator plays a crucial role in determining the overall financial burden of the loan. The higher the principal, the greater the interest costs over the life of the loan. Borrowers often aim to manage their principal effectively by making extra payments or negotiating favorable terms to minimize the total repayment amount.

For lenders, the principal amount is a crucial factor in assessing risk and establishing interest rates. The borrower’s creditworthiness, the purpose of the loan, and the term of repayment are all considered when determining the principal and associated interest rates.

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Steps to Calculate

In the case of EMI, the outstanding amount at any point in time can be calculated by using the following steps

  1. Firstly, the opening loan amount has to be determined.

  2. Next, the rate of interest to be charged on loan during the period (say annually) has to be figured out.

  3. Now, the interest payment for the month can be calculated by multiplying the rate of interest with the opening loan amount and then dividing the result by 12 (since r is the annualized interest rate), as shown below.

    Interest payment = Opening loan amount * Rate of interest /12

    Principal repayment = EMI – Interest payment

    Outstanding principal = Opening loan amount – Principal repayment which can be further expanded as below,

    Outstanding principal = Opening loan amount – (EMI – Interest payment)
    Outstanding principal = Opening loan amount + Interest payment – EMI

Examples

Now that we understand the basics of a home principal loan amount or any other form of loan let us apply that knowledge to the practical application through the examples below.

Example #1

Let us take the example of company ABC Co. Ltd which is a gym facility located in the city of California. The company took a 2-year loan of $200,000 last month to fund its ongoing expansion plans. The CEO of the company asked the accountant to calculate the outstanding loan principal amount after the first monthly payment of $8,864.12 is made. The bank charges an interest rate of 6%. Determine the outstanding principal for the accountant after the first payment.

As per the question,

Interest paid in the month = Loan amount * Rate of interest / 12

lOAN PRINCIPAL 1

= $1,000.00

Principal repaid in the first month = EMI – Interest payment

lOAN PRINCIPAL 1-2

= $7,864.12

Outstanding principal after first payment = Loan amount – Principal repaid

lOAN PRINCIPAL 1-3

= $192.135.88

Therefore, after the first monthly payment, the outstanding amount is $192.135.88.

Example #2

Let us take the example of company XYZ Ltd which has taken a one-year loan of $1,000,000 for setting up a new tool manufacturing unit in the town. Now, an analyst intends to check the impact of the rate of interest on the outstanding principal after the first monthly payment. Help the analyst determine the principal based on the following information:

As per the question,

The bank charges an interest rate of 5% and a monthly payment of $85,607.48

Interest paid in the month = Loan amount * Rate of interest / 12

Example 2

 = $4,166.67

Principal repaid in the first month = EMI – Interest payment

Example 2-1

 = $81,440.81

Outstanding principal calculation amount after first payment = Loan amount – Principal repaid

Example 2-2

= $918,559.19

The bank charges an interest rate of 10% and a monthly payment of $87,915.89

Interest paid in the month = Loan amount * Rate of interest / 12

Example 3

= $8,333.33

Principal repaid in the first month = EMI – Interest payment

Example 3-1

= $79,582.56

Outstanding principal calculation after first payment = Loan amount – Principal repaid

Example 3-2

 = $920,417.44

How To Reduce?

Reducing the loan principal not only shortens the repayment period but also minimizes the overall interest paid. Therefore, it is important to touch upon this aspect of this concept through the points below. It also helps us understand the loan principal amount calculator better.

  • Make Additional Payments: One effective way to reduce the loan principal is by making extra payments whenever possible. This can be in the form of additional monthly payments or occasional lump-sum payments. These contributions directly decrease the outstanding principal amount.
  • Refinance the Loan: Explore opportunities to refinance the loan at a lower interest rate. When refinancing, the new loan replaces the existing one, potentially reducing monthly payments and allowing more funds to be directed toward the principal.
  • Use Windfalls or Bonuses: Apply unexpected financial windfalls, such as tax refunds, work bonuses, or inheritance money, toward the loan principal. Using such one-time sums can make a substantial impact on reducing the overall debt.
  • Negotiate Favorable Terms: Contact the lender to discuss the possibility of negotiating more favorable loan terms. Some lenders may be open to adjusting interest rates or providing a temporary reduction in the principal, especially if it helps avoid default.

Relevance and Use

From the point of view of a borrower, it is very important to understand the underlying concept of principal because, during the life of the loan, the interest is charged based on the outstanding principal amount. In today’s financial setup, most of the bank loan repayment is characterized by EMI, which includes both the interest payment and the principal repayment. As such, the borrower should be cognizant of the fact that the money that goes into the payment of EMI doesn’t actually reduce the principal entirely because a portion of it pays off the interest charged. The portion of principal repayment is low in the initial EMI payments; however, it increases gradually over the period of time until the maturity of the loan.

On the other hand, this is also important from the point of view of a banker since, based on the outstanding home loan principal amount or any other loan, a banker also has to manage their liability. It means that a banker also needs to finance the outstanding principal amount by raising deposits from its customers. Besides, the interest income is calculated based on the principal, and it is the primary source of income for a bank. Therefore, it can be seen that the principal is significant information for both borrowers and lenders.

Loan Principal Amount Vs Loan Amount

Let us understand the differences between loan principal amount and loan amount through the comparison below.

Loan Principal Amount

  • The loan principal amount is the initial sum of money borrowed from a lender.
  • It forms the core of the loan and is the basis for calculating interest and determining the overall cost of borrowing.
  • Borrowers are obligated to repay the principal amount over the agreed-upon period, along with any accrued interest.
  • As payments are made, a portion goes toward reducing the principal, influencing the amortization schedule of the loan.
  • The size of the principal directly impacts the overall financial burden of the loan, influencing total repayment costs.

Loan Amount

  • The loan amount is the total sum of money approved and provided by the lender to the borrower.
  • It comprises the loan principal and any additional fees, charges, or costs associated with the borrowing, such as origination fees or insurance premiums.
  • Lenders assess various factors, including the borrower’s creditworthiness and purpose of the loan, when determining the approved loan amount.
  • The loan amount provides flexibility for borrowers to cover not only the principal but also associated expenses, ensuring they have the necessary funds for their financial needs.
  • Loan agreements typically specify both the loan amount and the breakdown of fees and costs included in the total borrowing.

This has been a guide to Loan Principal Amount and its definition. Here we discuss its examples, how to reduce, and compare it with loan amount. You can learn more about from the following articles –

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