Principal

August 31, 2024 Credit and Lending

Principal is the amount borrowed or invested before interest, returns, and most charges are added.

On this page

In lending, principal is the amount of money borrowed and still owed, excluding future interest and most fees. In investing, it can mean the original amount invested; for a bond, it commonly refers to the face amount due at maturity. The word can also mean a person who authorizes an agent, but this page focuses on the financial amount.

Key Takeaways

  • Original principal is the amount advanced when the loan begins.
  • Outstanding principal is the unpaid principal after advances, repayments, and any permitted capitalized amounts.
  • Interest is calculated using a principal balance, but the exact balance and day-count method come from the contract.
  • Loan value is ambiguous: it may mean principal, current carrying amount, market value, or a lender’s maximum advance. Confirm the context.
  • Maximum loan amount is an approval or program limit, not necessarily the amount ultimately borrowed.
AmountMeaningCan differ from principal?
Original principalAmount initially borrowedIt is the starting principal
Outstanding principalPrincipal still unpaidYes, after repayment or additional draws
InterestCharge for using borrowed moneyYes; normally calculated separately
PaymentCash paid on a due dateYes; may include interest, principal, fees, or escrow
Payoff amountAmount required to close the loan on a stated dateYes; may include accrued interest and charges
Maximum loan amountHighest amount permitted by underwriting or program rulesYes; the borrower may use less
Market or carrying valueEconomic or accounting measurement of the loanYes; can be above or below principal

How Principal Changes

For a standard amortizing loan, the next principal balance is:

$$ P_{t+1} = P_t - \text{Principal Repaid}_t $$

For a revolving account or a loan that permits later advances:

$$ P_{t+1} = P_t + \text{New Advances}_t + \text{Capitalized Amounts}_t - \text{Principal Repaid}_t $$

Capitalization means an amount such as permitted unpaid interest is added to principal. Whether and when that can occur depends on the agreement and applicable rules.

Example

A borrower receives a $20,000 loan. The first monthly payment is $600, of which $150 is interest and $450 is principal.

  • Original principal: $20,000
  • Principal repaid: $450
  • Outstanding principal after the payment: $19,550
  • Total cash paid: $600

The payment and the principal reduction are not the same. On many level-payment loans, the interest share falls and the principal share rises over time as the balance declines. See loan amortization.

How to Verify Principal

Use a dated source because principal changes over time:

  • the closing disclosure or promissory note for original principal;
  • the latest statement or servicing record for outstanding principal;
  • the amortization schedule for expected allocation of payments;
  • the payoff statement for the amount required to settle on a specified date;
  • the credit agreement and borrowing-base certificate for revolving availability.

Common Mistakes

Calling the full payment principal. Payments often include several components.

Using the original amount as the current balance. Repayments, additional draws, and capitalization can change principal.

Treating maximum amount as guaranteed funding. Approval limits can be reduced by collateral, program, or draw conditions.

Assuming principal equals economic value. A loan’s market or accounting value can differ because of credit risk, rates, fees, and measurement rules.

Browse Credit and Lending