What Is a Loan Principal?
Whether you were looking to buy a house or invest your money in a good opportunity, you have probably heard of loan principal. In this article, we will explain what loan principal is and its definition.
When you take out a loan, your payments will be split into two parts; principal and interest rate. So the principal amount of a loan is the original sum of money borrowed in a loan or investment. On top of that, the principal of a loan can also be referred to as the face value of a bond, the owner of a private company, or the chief participant in a transaction.
To sum it all up, the principal on a loan applies to all kinds of debts, such as car loans, business loans, or credit card balances. It includes the exact amount you borrowed with the inclusion of interest rates, charges, fees, and possible extra charges the lender can impose.
How Does the Loan Principal Work?
In order for you to understand better how the principal on loan works, we will give you an example. So, let’s say you take out a loan in the amount of 10,000$. You will have to make a down payment of 2,000$, so the principal on your loan is now 8,000$.
The first month’s payment is going to be calculated as 8,000$, which is the loan principal, and then you will have a 4% interest rate that is spread over 12 months. The interest balance is 27$, and monthly payments will help you to pay those 27$ monthly interest rate and 473$ to reduce your loan principal as time goes on. As you make regular payments, your loan principal will decrease until it reaches 0.
Loan Principal vs. Interest: What’s the Difference?
When you borrow money, the lender (the person or company who loaned you the money) is usually entitled to a percentage of the total amount borrowed as a “loan principal.” This is what the lender really owes you, and it’s what you need to pay back with interest.
However, there’s another term that often gets confused with loan principal: interest. Interest is what you pay the lender each month for borrowing the money. It may seem like a small amount, but over time it can add up to a lot of money.
In simple words, the loan principal is the amount you borrowed in total, while the interest rate is the percent you repay back to the lender each month.
How Do You Determine the Loan Principal?
Now that we have covered more about the loan principal and what it actually is let’s take a look at how it’s calculated. The formula for calculation is rather complicated since it goes like this.
a / {[(1+r)^n]-1]} / [r(1+r)^n] = p
a = total loan amount, r = periodic interest rate, n = total number of payment periods, p = monthly payment.
It looks very difficult and hard to do, so we suggest you look up an online loan principal calculator. It will require from your side a couple of simple pieces of information, such as the initial loan amount and the payment frequency, and based on that, and you will be able to find out the full purchase cost and total interest rate.
What Effects Do Loan Principals Have on Taxes?
Taxes are one of the main concerns when it comes to finances. Not only do they have an impact on your wallet, but they can also have an impact on your overall financial stability. One of the most important aspects of taxes is understanding how loan principals affect them. Loan principals are the amount you borrow, and they can have a big impact on your taxes. Here is a look at what effects loan principals have on taxes and how to best manage them.
Depending on your tax situation, loan principals can be deductible or non-deductible. Deductible loan principals include interest, original principal, and any amounts paid in cash. Non-deductible loan principals include any amounts that are financed with debt charges or other payments such as rent or mortgage payments.
The amount of deduction you qualify for will depend on a few factors, including the type of loan you took out and the income level you fall into. If you take out a personal loan for $5,000 and your income falls into the 10%-25% tax bracket, you would be able to deduct $400 in interest (10% of $5,000).
How to Pay Off a Loan Principal Faster
A loan principal is an amount you owe on your loan, expressed as a percentage of the total cost of the loan. To pay off a loan principal faster, you need to work toward a faster payoff schedule. There are a few things you can do to make this happen: reduce your monthly payments, make larger lump-sum payments, or extend the term of the loan. If that is not enough for you, here are five more ways to speed up the repayment.
- Make bi-weekly payments. This can come in very handy in the long run. Instead of making monthly payments on your loan, you can simply submit half payments every two weeks.
- Round up monthly payments. To give a simple example, if your car’s monthly payment is 220$, you can round it up to 250$. Using this tactic, you can knock down a couple of payments and repay the loan faster.
- Make extra payment once a year. With a work bonus or a tax refund, you can make a larger payment once a year to reduce your loan life by several months or even years.
- Refinance. One of the best ways to pay off your loan faster is to refinance. In the case that your credit score has improved drastically or the interest rates dropped since you took out a loan, this is a great option for you.
- Boost your income. The best way to pay your loan back faster is to make more money. It sounds simple when said, but it can also be easy to do. You can sell stuff online, have a baking sale on the weekend or just find a part-time job that can make you even 300$ since that can go towards repaying the loan.
Final Thoughts
When taking out a loan, it’s very important to know how much you will need to pay back and how that is calculated. In this article, we explained more about the loan principal, how it’s calculated and how you can repay it back.
We all need money from time to time, but knowing what you’re getting into is crucial if you don’t want to end up in debt. Now that you know more about loan principal and how you can calculate it, we suggest you consult with your financial advisor before signing your name on the dotted line.
