What is a Principal Balance? Definition, Example, 3 Facts

Some investors use the principal balance to determine a company’s value. It is a method for evaluating a company’s financial health. Insolvent is a company with a negative principal balance. This article provides additional information on principal balances. 

What is a Principal Balance?

The principal balance is the remaining amount of a loan that must be repaid to satisfy the obligation. It does not account for future interest or fees that will accrue.

The principle balance is equal to the total amount initially borrowed minus the amount previously repaid against it, excluding accrued interest.

What is a Principal Balance?

After the entire principal amount has been repaid, the loan is repaid. This process of making interest and principal payments is called amortization, and it is common for mortgages and auto loans.

The interest on the loan is calculated based on the principal balance. In most cases, the borrower will receive a monthly statement outlining the remaining balance of the loan’s principal, but this can be easily determined by consulting an online amortization schedule.

To repay a loan in full, it is necessary to contact the lender and request a payback amount that consists of the principal balance plus any additional interest and fees.

What is a Principal Balance?

In a loan with compound interest, the monthly interest is added to the balance of the principal. This indicates that the principal amount will increase, and interest will be calculated based on the new, higher principal amount. When applying for a loan, be sure to carefully read all documentation. Normal credit card interest is calculated by compounding.

Paying more than is required is a simple method for early debt repayment. Check with the lender, but in most cases, the excess funds will be immediately applied to the loan’s principal.

If the amount owed one month is $300 USD and the amount paid is $350 USD, the extra $50 USD will be applied to the loan’s principal to reduce the total amount owed. Again, be sure to carefully read all loan documents, as certain loans may contain prepayment penalties.

Example Of a Principal Balance

Illustrations are the most effective way to convey this concept. Obtaining a $100,000 USD mortgage at 6% interest results in an initial principal balance of $100,000 USD. The borrower will make monthly payments to the mortgage lender.

The majority of the payment will be applied to the interest accrued, with the remainder going toward the principal balance. As the months progress, the same payment amount will be made, but a larger portion will be applied to the principal.

What is a Principal Balance?

What is the difference between the principal balance and the payoff quote?

The principal balance is the amount still owed on the original loan amount, exclusive of accrued interest and finance charges. A payback quotation is the total amount required to repay the loan, including any applicable interest and/or finance charges.

Payoff estimates are based on a 30-day period of interest and/or finance charges. After 30 days, a new estimate of the correct amount required to repay the loan is required.

Conclusion

Regarding a mortgage or other debt instrument, the principle balance is the amount owed to satisfy the repayment of an underlying obligation, excluding interest and other fees.

An amortized mortgage loan applies a portion of each monthly payment to the principal balance and the remainder to interest.

A loan with interest-only payments does not require monthly principal payments, but such payments are permitted.

FAQ

The principal balance of your loan is the original amount you borrowed, while the interest is what you pay for the privilege of borrowing the money. With most loans, your monthly payment is split up between principal and interest.
As a general rule, making extra payments just toward the principal balance can help you pay off a loan faster and reduce the overall cost of the loan.
Your principal balance is not the payoff amount because the interest on your loan is calculated in arrears. For example, when you paid your August payment you actually paid interest for July and principal for August.
Because federal income-driven plans allow borrowers to make payments based upon what they can afford rather than what they owe, the monthly interest on the loan may be higher than the monthly payment. When this happens, the total student loan balance increases with each passing month.
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Pat Moriarty
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