What is Principal?

What is Principal?

If you are working with any kind of financial product, it’s important that you know the terminology. It’s not just about being able to speak to a loan agent intelligently – it’s about being able to make informed decisions about the products that you might choose to purchase. One of the most important terms you can know when looking for a loan is ‘principal’, one of the first terms that you’ll see when filling out the relevant paperwork. Understanding the basic definition of this term as well as how it will function in regards to your loan is a good first step in figuring out whether a loan is right for you.

The Definition

Principal is a term with a few financial meanings. It can, for example, refer to a party to a transaction in many contracts. When it comes to loans, though, the term is almost always used to specify the amount of money that will be borrowed. If you are taking out a five thousand dollar loan, for example, the principal balance of the loan will generally be five thousand dollars. This may not be all of the money you will owe, but it’s the money that you will receive.

Principal Balance

Typically speaking, this is what you’ll be working to pay off after you take out a loan. Your payments will typically go partially to the principal and partially to interest. Extra payments made on your loan will typically go towards the principal balance. All calculations of fees and interest are usually related to this balance as well, making it one of the most important things you’ll need to know. The faster you manage to pay down this part of your balance, the faster you will be able to pay off the entire loan.

Why it Matters

For many borrowers, knowing the principal amount of the loan is the most important thing they’ll hear from a lender. This is the amount of money needed by the borrower, though sometimes the money received will not actually be the same as the total of the principal balance. If a borrower is unaware of the principal, he or she might not know how much he or she is borrowing – or even how much he or she should be receiving from the loan originator. Understanding this term allows one to plan how to use the borrowed money.

At the same time, an understanding of this concept generally allows for better financial planning. If you know what the principal is on your loan, you know how to calculate the interest payments. While it might involve a bit of math, it’s very simple to figure out how much you’ll pay over time. This, in turn, allows an individual to know whether or not to accept a loan at a specific interest rate. While it’s always a good idea to accept a lower interest rate, having an idea of how that rate will be calculated will help an individual to determine if it’s feasible to accept a loan at a higher rate.

Principal is absolutely one of the terms that a borrower must know before taking out a loan. As it refers to the sum that the borrower wishes to borrow, it will be stated multiple times in a lending agreement and many of the most important aspects of the loan will be related back to that amount. Take some time to learn a bit about the financial terminology related to your loan; doing so will not only make it easier to understand the agreement, but it can also help you to make better borrowing decisions.