The principal is a term that has a lot of meanings in the financial industry. Among one of the most preferred meanings, it usually refers to the original amount of money borrowed in a loan or given in an investment. Similar to this, it can also refer to the face Value of bond.
A principal is also known as the balance on the loan. The monthly interest is calculated using this, by multiplying the principal balance to the monthly interest rate. The faster the borrower repays the principal, the less interest will be added to the original amount.
At the beginning of taking a loan, the principal is the original amount borrowed. As you start repaying it, the principal becomes the outstanding balance of the loan, without any fees accrued or interest.
A loan generally has both principal and interests. Depending on the type of loan, the amount for interest and principals will be decided. Depending on the type of loan you have, your payments will include money for both principal and interest. For example- Fixed -rate mortgage will send all the first few payments to interests.
In different contexts, the principal has different meanings. For borrowing, it refers to the initial size of the loan or it can also mean the amount still owed on a loan. For example, If you take out a $90,000 mortgage, the principal becomes $90,000. If you pay off $60,000, the remaining $30,000 left to repay is also called the principal.
The amount of interest paid depends on the loan and the loan is determined by the principal sum. For example, If a borrower whose loan has a principal amount of $20,000 and an annual interest rate of 10% will have to pay $1000 in interest for every year and the loan is outstanding.
When you make monthly payments for a loan, your amount gets split into two parts. First, it is used to cover all the interest then the remaining part is given to the principal sum. Correctly paying down the interests is the only way to reduce the amount of interest for each month.
ZERO PRINCIPAL MORTGAGE
It is also called an “interest-only mortgage”. A zero principal mortgage is a type of financing in which the borrower’s regular repaid amount only covers the interest charged each month on the loan, as opposed to both interest and principal. As a result, there is no progress in paying off or reducing any principal balance of the loan by paying off the whole debt or by building equity in the mortgaged property.
This becomes a major reason why this type of mortgage is not preferred by the homebuyers. But, there are some situations where they can be found useful. For example – If a borrower has just begun a career and is earning relatively low at present but has a chance to earn fairly more in future, they can invest here. Then when they start to earn more, they can manage to a conventional mortgage, that includes principal payments too.
FACE VALUE OF A BOND
In debt instrument’s context, the principal can also refer to the face value, or par value, of a bond – which means that the actual amount listed on the bond itself. A bond’s principal is, typically, the amount of money the owner of the bond owes to the bondholder in the completion of the bond’s maturity. The principal of the bond is exclusive of any coupon, or recurring interest payments. For example, a 20-year bond may be issued with $20,000 face value and have $10 recurring coupon payments semi-annually. The principal is $20,000 – independent of the $11,000 worth of coupon payments over the life of the bond.
A principal of a bond is not necessarily its price. Depending on the condition of the bond market, a bond can be purchased for more or less than its principal.
The amount of principal that you have paid off tells the equity you have in your home, considering the market value is close to what it was when you bought it. As you grow your equity, you can use that investment as collateral for low-cost home equity loans or home equity lines of credit.
There are Some lenders who allow you to pay the principal payments more quickly by using an accelerated pay table. Some lenders charge a prepayment penalty, to make sure you understand all your options before making any decisions.