Principal

The loan principal refers to the loan amount that is borrowed or owed by a borrower.

The original principal is the original amount that was borrowed by the borrower on a loan. While the principal balance is a term used to refer to the amount of principal that is still owed on a facility at any period of time after payments have been made towards reducing it.

The interest charged on loans such as personal loans are calculated based on the principal.

However, it must be noted that some types of facilities use simple interest where interest charges are constantly based on the original principal. While other types of facilities such as mortgage can be based on a reducing principal as it slowly gets paid off by the monthly scheduled payments.

How much do borrowers owe a lender?

Because repayments towards debt consist of principle and interest, borrowers can often make the mistake of assuming the amount they actually owe to a lender is the sum of all repayments.

For example, a $20,000 5 year car loan at 5% might look like the total amount owed to the lender would be $25,000 after adding up all the installments. This can cause a borrower to be confused the actual amount of money that has to be repaid if he is to fully redeem the loan after two years.

The same can be said of other types of loans such as personal loans and housing loans.

When borrowers take action to redeem a loan before it’s maturity date, they usually find that the amount of principal they have to pay to fully settle the debt is much less than they anticipated.

This is because the big amounts of monthly repayments have interest charges taking up a huge portion of it.

Other ways how principal is used

Because the principal is ultimately how much a borrower owes to a bank, it is no surprise that lenders would want it to be paid off as slowly as possible.

This is so that interest can continue to be charged on it.

At this point it is important to note that the principal is the amount that lenders base their return on investment (ROI) and yield calculations on.

And forecast interest revenue might not be realized when borrowers makes full repayment.

This is why when full repayments occur, lenders tend to charge a redemption penalty fee to borrowers to make up for the interest revenue that they had forecasted to book in.

Sometimes, the method of playing with principal can also leave a question of ethics.

This can be observed in the market for personal loans where a borrower would usually incur an administration or processing fee which is deducted from the loan amount before disbursement of the funds.

It means that a borrower does not receive the amount he or she borrowed, but the principal remains the same.

For example, an individual might take up a $10,000 personal loan and incur a 5% admin charge of $500. This is directly deducted from the $10,000 and $9,500 is disbursed to the borrower instead of the $10,000 officially borrowed. The interest charges would then be based on $10,000 even though the borrower never received that amount.

The principal can work in even weirder ways in credit cards.

If $1,000 has been drawn down on a credit card, the interest charged on that $1,000 would be added to the $1,000 to become the new principal that has to be repaid.

Debt settlement

It must be noted that when loans go into default, the primary objective of a lender is to get it’s money back.

When it is next to impossible to recover the principle and owed interest from someone who is already in financial trouble, they’d want to at least get back the principal.

In such occurrences, it is not uncommon for lenders to agree a debt settlement with the defaulter as long as the principal is repaid.

When lenders are feeling charitable, they might even agree to accept part of the principal as settlement.

The borrower would then pay the principal balance on a loan or the reduced amount that is agreed for settlement of the debt.

While this can seem like a favorable situation to a borrower, it must be noted that this would be recorded in the person’s credit report as a debt settlement… which is as good as a bed debt.

This person would not be able to obtain most types of credit facilities in the near future by himself.

Inheritance

Late Payment Fee

Grace Period

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