Loan Principal Amount

Loan Principal Amount Definition

Loan Principal Amount refers to the amount which is actually given as the loan from the lender of the money to its borrower and it is the amount on which the interest is charged by the lender of the money from the borrower for the use of its money.

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.

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For eg:
Source: Loan Principal Amount (wallstreetmojo.com)

Steps to Calculate Loan Principal Amount

In the case of EMI, the outstanding amount at any point in time can be simply 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

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

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 that 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 loan principal amount, a banker also has to manage its own 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 major source of income for a bank. Therefore, it can be seen that the principal is significant information for both borrowers and lenders.

This has been a guide to what is Loan Principal and its definition. Here we discuss the steps to calculate the Loan Principal amount along with practical examples. You can learn more about from the following articles –

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