When it comes to loans, you may have heard of the term “principal payment.”
Understanding principal payments is helpful for managing personal finances and ensuring that you pay off your debt in a timely manner. Keep reading to explore what principal payment is, its importance, and how it impacts loan repayment.
Here’s what we’re going to cover:
- What is a loan principal?
- Understanding principal payments
- What components make up a loan payment?
- Fixed principal payments vs. fixed total payments
- Oportun: Affordable lending options designed with you in mind
Key takeaways
- When you make a loan payment, you’re paying toward two parts: the principal and the interest.
- Principal payment is the part of a loan payment that reduces the original loan amount.
- Interest payment is the part of a loan payment that goes toward paying interest charges.
- A repayment plan determines how payments toward principal and interest are distributed, and it varies between products and lenders.
What is a loan principal?
The principal refers to the amount of money borrowed, excluding interest. When you take out a loan, such as a mortgage, car loan, or personal loan, the principal is the original sum you agree to repay over a specified period. Even as you pay it down, that borrowed amount is still called the principal.
Say your car cost $10,000. You put $1,000 down and finance $9,000. The principal amount is $9,000. As you pay it back, your principal will go down.
Understanding principal payments
At its core, the principal payment refers to the portion of a loan payment that goes toward reducing the original amount borrowed. In other words, it’s the repayment of the initial sum borrowed, excluding interest.
What components make up a loan payment?
A loan payment is generally composed of two main parts: The principal payment and the interest payment.
Principal payment
The principal payment is the portion of the loan payment that reduces the outstanding balance. For example, if you borrow $1,000 and pay $100 toward the principal, the remaining balance would be $900.
Interest payment
The interest payment is the portion of the loan payment that goes toward the interest charged by the lender. Interest is the cost of borrowing and is usually expressed as a rate of the principal. For example, you may have a 10% interest rate. How much you end up paying in interest depends on the length of the repayment period.
Fixed principal payments vs. fixed total payments
There are different ways to structure loan repayments. Said another way, there are different calculations used for how a loan is repaid. For example, two such structures have fixed principal payments or fixed total payments (also called even principal payments or even total payments).
Fixed principal payments
When the size of a loan payment decreases over time, it’s a fixed principal payment plan. The principal amount paid each period remains constant, but the total payment amount decreases because the interest is calculated on the decreasing principal balance.
Consider a $10,000 loan with a term of 5 years and an annual interest rate of 5%:
| Year | Principal Payment | Interest Payment | Total Payment |
|---|---|---|---|
| Year 1 | $2,000 | $500 | $2,500 |
| Year 2 | $2,000 | $400 | $2,400 |
| Year 3 | $2,000 | $300 | $2,300 |
| Year 4 | $2,000 | $200 | $2,200 |
| Year 5 | $2,000 | $100 | $2,100 |
Fixed total payments
When the size of the loan payment remains the same over the whole repayment schedule, it’s a fixed total payment. The total amount paid each period remains the same but the portion going toward the principal and interest changes. Early payments mostly cover interest, while later payments cover more principal.
Consider a $10,000 loan with a term of 5 years and an annual interest rate of 5%:
| Year | Principal Payment | Interest Payment | Total Payment |
|---|---|---|---|
| Year 1 | $1,528 | $500 | $2,028 |
| Year 2 | $1,605 | $432 | $2,028 |
| Year 3 | $1,688 | $340 | $2,028 |
| Year 4 | $1,776 | $252 | $2,028 |
| Year 5 | $1,872 | $156 | $2,028 |
These basic examples are for understanding only. Repayment calculations can consider other factors, like whether the interest is compounding.
Oportun: Affordable lending options designed with you in mind
Now that you know what a principal payment is, you may want to apply for an affordable loan through Oportun. Visit our homepage to learn about:
- Personal loans
- Secured personal loans
- Savings
- And more!
Sources:
Credit Karma. What is a principal-only payment?
Go Cardless. How to Calculate Principal Payment
Corporate Finance Institute. Principal Payment
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