Principal is the original amount of money borrowed or the remaining balance on a loan. If you borrow $200,000 for a mortgage, the principal is $200,000.
Principal and Interest
Interest is calculated on principal:
- Borrow: $200,000 (principal)
- Interest rate: 6%
- Annual interest: $200,000 × 0.06 = $12,000
As you make payments, principal decreases, so interest charged decreases.
Amortization Example
Year 1: Principal $200,000, Interest $12,000 Year 5: Principal $185,000, Interest $11,100 Year 10: Principal $165,000, Interest $9,900
Same loan, but principal is lower, so interest is lower.
Payment Breakdown
Early in a loan, payments mostly cover interest. Late in a loan, payments mostly reduce principal.
30-year mortgage, $200,000 principal:
- Month 1 payment: $1,200 (mostly interest, ~$100 principal)
- Month 360 (final): $1,200 (~$10 interest, $1,190 principal)
Same payment, but composition shifted from interest-heavy to principal-heavy.
Paying Extra Principal
If you pay an extra $100/month toward principal:
- Regular 30-year mortgage: $720,000 total paid
- With extra principal: $685,000 total paid
- Savings: $35,000, plus loan paid off in ~25 years
Paying extra principal is the most direct way to reduce total interest and shorten loan duration.
