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The principal on a loan is the original amount you agree to repay. It can affect how much interest you owe with each payment, and a portion of each loan payment generally goes toward the principal. Over time, the principal balance decreases—and making extra payments could help you save money and pay off the loan sooner.
What Is Principal?
A loan's principal is usually the amount you borrow when you get a loan. However, the amount you receive might be lower if the lender charges fees—such as an origination fee—that get taken out of the loan's proceeds. There are also situations when fees or interest get added to the loan's principal during repayment.
Principal vs. Interest
Principal is how much you borrow, and interest is what a creditor charges you for borrowing money. Creditors generally charge interest in one of two ways:
- Simple interest: This interest rate applies to your principal balance.
- Compound interest: This interest rate applies to your principal balance plus outstanding interest.
In either case, the higher your interest rate, the more interest you'll pay to borrow money. Improving your credit scores—and overall creditworthiness—and shopping for a loan might help you find offers with lower interest rates.
Learn more >> How to Improve Your Credit Score
Example of Loan Principal and Interest Payments
A loan's interest rate will generally apply to the principal balance. With simple interest, the rate tells you how much interest will accrue over a year.
Say you take out a $20,000 personal loan that has a five-year term, 10% interest rate with simple interest and no origination fee. The 10% interest rate would lead to $2,000 in interest accruing during the first year if your principal balance stayed the same.
However, your loan is likely amortized. Part of each payment covers the interest that's accrued during the month, and the remainder pays down your principal balance. The breakdown of your monthly payments is calculated so the payments stay the same during the five years.
You pay the most interest in the beginning of your loan term—when the principal balance is highest. Using the payment schedule from the Experian personal loan calculator, we can see that the first $424.94 payment is split so $166.67 goes to interest and $258.27 goes to principal.
As you pay down the principal, less interest accrues during the month, and a larger portion of your payment goes toward the principal. By the 59th payment, you only pay $5.99 in interest and $417.95 to the principal.
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Can Your Principal Payment Change?
As you pay down an amortized loan, your principal balance decreases. The amount of your monthly payment that goes toward principal over time, then, increases, while the amount of interest you pay will decrease.
The principal balance on your loan will generally fall or rise when:
- You make loan payments. Most loans are amortized, and your principal balance decreases with each payment.
- Your interest gets capitalized. You might be able to temporarily pause your payments by putting a loan into forbearance or deferment, but interest will generally keep accruing. In some situations, such as with certain student loans, the interest gets capitalized—added to your principal balance—when your payments restart.
- The loan is modified. Creditors may agree to permanently change the terms of a loan when borrowers are struggling to afford their payments. A loan modification will generally extend the repayment term or lower the interest rate to decrease the monthly payment. In some cases, the lender could forgive a portion of the principal balance.
There are a few exceptions when you can pay a loan on time without the principal changing.
For example, if you have an interest-only home equity line of credit (HELOC), you may only need to make interest payments during an initial draw period. As a result, the principal balance stays the same until you start the repayment period.
Your principal also won't change if your minimum monthly payment doesn't cover all the interest that accrues. In this situation, your total balance actually increases over time—a process called negative amortization.
How to Pay Off Your Principal Balance
Paying down the principal balance decreases how much interest accrues and is essential to paying off the loan.
You also might be able to make extra payments and have the entire amount go toward your loan's principal. Although a principal-only payment won't change your monthly payment amount, it will decrease how much interest accrues. This can save you money overall, and help you pay off the loan sooner.
Some lenders charge prepayment penalties if you pay off the entire loan early—either with direct payments or through refinancing. Review your loan agreement to make sure you don't wind up paying more in fees than you save by
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Improve Your Credit to Get a Lower Interest Rate
The interest rate on your loan or line of credit can affect your monthly payments and your total cost of borrowing. Many factors can affect the interest rate you receive on a loan or line of credit, but your credit score is often a major factor.
You can check your credit score and get your free credit report from Experian to find out how you might be able to improve your credit. If you're ready to apply, Experian can also match you with credit cards and personal loans based on your unique credit profile.