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Loan Principal Definition and Explanation

Loan Principal - What It Is? How Does It Work?
Sulaiman Abdur-Rahman
Sulaiman Abdur-RahmanUpdated July 17, 2023
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Loan principal is the amount of money you borrow. Lenders may provide principal as a lump sum of money for a specific or general purpose.Principal is generally the foundation of a closed-end credit product, including mortgage loans, personal loans, auto loans, and student loans. In addition to repaying principal, borrowers may also have to pay interest charges and fees over the life of the loan.Borrowers are generally expected to repay loan principal in full by the end of the repayment term, plus any interest charges and fees that may apply. Below we highlight how loan principal works.

What Is the Principal of a Loan?

Loan principal is the amount of money you borrow. For example, banks, credit unions, and private lenders may offer large personal loans up to $100,000. Some borrowers, however, may not qualify for large amounts of principal. Your credit score and debt-to-income ratio may impact how much of a personal loan you can get from a lender. Regardless of the loan amount you receive, lenders generally expect borrowers to repay the loan principal in full over the life of the loan.

Understanding Loan Principal

Understanding loan principal is a matter of finance. Loan principal is the amount of money you borrow from a lender under a signed loan agreement. Borrowers may agree to repay the principal loan amount plus any interest charges and fees that may apply.Some loans may feature an interest-only payment period, but principal is generally the foundation of closed-end credit products. These products can include auto loans, personal loans, and mortgage loans. Some lenders may offer auto loans with 0% annual interest rates.A personal loan provides borrowers with a lump sum of money that borrowers must repay over a set period of time. Such loans may feature monthly payments over a term that can range from 12 months to seven years.Failing to pay and defaulting on a personal loan can have a major impact on your credit score.

How to Identify Your Loan Principal

Your loan principal is the initial amount of money that you borrowed, whether that was for a mortgage, a personal loan, or an auto loan. If you’ve been making payments on your loan and are wondering where your current loan principal stands, take a look at your monthly statement. Monthly statements show the breakdown of principal and interest and how much is being applied to each when you make your monthly payments.Recommended: How to Read a Credit Card Statement

How Does Personal Loan Principal Work?

The way personal loan principal works is that a bank, credit union, or private lender may loan a lump sum of money that borrowers must repay over a set period. A lender, for example, can loan $5,000 over a four-year term in which the borrower is expected to repay the $5,000, plus interest, by the loan maturity date. The borrower in this case may make 48 monthly payments in accordance with a fixed payment schedule to satisfy the debt.

Loan Principal vs. Loan Interest

Loan principal is the amount of money you borrow and loan interest is the finance charge you may pay for borrowing the principal. The below table highlights the differences between loan principal and loan interest:
Loan principalLoan interest
Represents the total money or financing a lender offers under a loan agreementRepresents a finance charge you may pay for borrowing money
Generally serves as the foundation of closed-end creditA source of revenue for lenders

How Does Loan Principal Affect Taxes?

Borrowing money and repaying the loan principal may have no impact on taxes. Borrowing money and paying some loan interest charges, however, may entitle you to an income tax deduction.The student loan interest deduction, for example, allows eligible taxpayers who have paid interest on a qualified student loan to claim a deduction on their federal income taxes.A tax deduction can reduce the amount of income tax you may have to pay or increase the size of your tax refund.Recommended: Guide to Personal Loan Interest Deductions

Are There Any Penalties for Paying Only the Loan Principal?

You could face penalties for paying only the loan principal if your loan also includes interest charges. A loan agreement between a borrower and lender may require the borrower to make fixed monthly payments toward principal and interest. Paying only principal can lead to default if the loan agreement includes interest charges in your total amount due.Lenders may consider a borrower in default if the borrower fails to make a required payment. Borrowers could face late fees if they fail to make a scheduled loan payment by its due date. Borrowers may also face penalties if they fail to make any required payments, including any interest charges or fees levied by the lender.

Are There Any Advantages To Paying the Loan Principal First?

Your monthly payment will include both the principal and interest. If you can increase your payment one month, it makes sense to put that toward the principal balance. The faster you can decrease your principal balance, the less you’ll pay in interest over the life of the loan.To make a principal-only payment, contact your lender prior to making the payment to ensure the extra amount gets applied to the principal only, as opposed to both the principal and interest.

3 Ways To Pay Down the Loan Principal Faster

You can pay down the loan principal faster if your loan agreement allows you to make extra payments toward principal. Some lenders may charge a prepayment penalty fee if you pay off your loan earlier than scheduled.If your loan features no prepayment penalty, you may pay the loan off faster and minimize your interest costs by making extra payments toward principal.Here are some of the benefits of making extra payments toward loan principal:

1. Interest Payments

Making extra payments toward principal can reduce the amount of simple interest you pay over the life of your loan.

2. Shorten Loan Term

Making extra payments toward principal may allow you to pay off your loan faster. Extra payments, for example, can shorten the loan term if the extra payments allow the borrower to repay the loan in full before the scheduled loan maturity date.

3. Cheaper Payments

Making small extra payments toward the principal can minimize the amount due on your final loan payment.For example, a $25,000 car loan with a 60-month term and 6% simple interest rate would include a $483.32 monthly payment obligation. The 60th and final payment on that loan would be about $139 if you’re allowed to pay $5 extra per month toward principal without penalty.

Other Important Personal Loan Information

There are at least 10 benefits of a personal loan, such as:Recommended: Debt Consolidation Loans vs Personal LoansAmong the advantages and disadvantages of a personal loan, they can help you build credit but may feature high rates of interest.Here are some additional factors concerning personal loans:

Loan Amount 

Lenders may approve applicants for a specific loan amount, also known as the principal loan amount. Personal loans can range from $1,000 to $100,000.

Loan Maturity Date

A personal loan can feature a predetermined payment schedule that may end with a final payment due on the loan maturity date. Borrowers are generally expected to repay the loan amount in full by the loan maturity date, if not sooner.

Loan Interest Rates

Personal loans may feature annual percentage rates of interest, also known as APR. Borrowers with excellent credit may qualify for the best rates.

Monthly Loan Payments

Borrowers can make monthly payments on a personal loan in accordance with their loan payment schedule. Monthly loan payments may go toward principal and interest charges.

Personal Loan Rates

The cost of a loan can include principal, interest, and fees. Borrowers are generally expected to repay loan principal in full by the loan maturity date. Some loans may feature an interest-only payment period, but the amount of money you borrow is the loan principal.Shopping around helps ensure that you’re getting the best deal you can. Lantern by SoFi makes this easy. With one online application, you can find and compare personal loan offers from multiple lenders.

Frequently Asked Questions

What is the principal of a loan?
Is the loan principal amount fixed?
What happens if you only pay the loan principal?
Is it better to pay interest or principal?
Is principal the same as loan amount?
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Photo credit: iStock/EmirMemedovski
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About the Author

Sulaiman Abdur-Rahman

Sulaiman Abdur-Rahman

Sulaiman Abdur-Rahman writes about personal loans, auto loans, student loans, and other personal finance topics for Lantern. He’s the recipient of more than 10 journalism awards and served as a New Jersey Society of Professional Journalists board member. An alumnus of the Philadelphia-based Temple University, Abdur-Rahman is a strong advocate of the First Amendment and freedom of speech.
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