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What Is Loan Principal and Why Is It Important?

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What Is Loan Principal and Why Is It Important?

Do you want to expand your business? Are you planning to upgrade your equipment or boost your cash flow? Or do you want to hire new staff? No matter what your reason is, a small business loan is beneficial.

However, getting the fund from a small business loan is only the start of your journey. It will impact your business budgeting, accounting, and taxes until you fully repay the loan. So, understanding small business loans, especially the concept of the loan principal, is critical for every business owner.

When you take out a small business loan, the lender calculates the amount you need to pack back, including the amount borrowed, interests, and even the additional fees incurred. They are added to the loan principal and overall repayment.

In this post, we will explore what loan principal exactly is, how it works, how it impacts your monthly payments and taxes, and more. Let’s start!

What is Loan Principal?

A loan principal refers to the amount you borrowed from a lender when you take out a business loan. If you get a $50,000 loan to purchase new office equipment, then the initial loan principal loan would be $50,000.

Your loan balance often comprises the principal and interest charges. So, the interest usually increases the balance even if the loan principal is initially $50,000.

If you reduce the loan balance amount, the principal goes down. After repaying the original loan amount, you will be left with a $0 principal.

Generally, lenders set up payment schedules, allowing the borrowers to pay the interest first. After that, they can pay the principal. While paying off the principal, the interest rate is charged against the smaller balance. In short, if you have a lower principal, you will pay less interest.

How Does Loan Principal Work?

Let us take the $50,000 equipment loan as an example to understand how a principal loan works.

As mentioned earlier, the initial loan principal is $50,000. This means a 6% annual interest rate will be charged by the business loan lender.

Once you receive the loan proceeds and make the first payment, the loan principal remains at $50,000. On the other hand, you need to pay $250, which is ($50,000 x (6%/12). Suppose your monthly payment is $1,000. $250 takes care of the loan interest, and the remaining $750 goes toward the principal.

Once you make the first payment, the loan principal goes down to $49,250. This amount keeps decreasing until you fully pay the amount your borrowed.

When calculating the monthly loan payments, the lender will amortize the loan, which spreads it out over time. In return, a schedule is created, allowing the borrower to determine how your loan will affect

your finances, including how much of the monthly payments go towards the loan principal, how long it takes to pay off your principal, or how much of the monthly payments go toward the loan interest.

What is the Difference Between Loan Principal and Loan Interest?

Loan interest is a critical factor in determining the amount you need to pay back. However, the loan principal is also crucial when choosing how much you have to repay.

The loan principal is the amount you borrow, while interest is the cost attached to borrowing that money. These figures are added by business lenders, credit unions, or banks to make a profit.

Your loan principal is the dollar amount, while your interest is the percentage. The interest amount you owe depends on the lender’s unique policies and your business credit history. If you have a stronger credit history and higher credit score, it often leads to a lower interest charge. So, it is critical to build good credit before taking out a business loan.

What is the Difference Between Loan Principal and Loan Balance?

Besides loan interest, the loan balance is also essential to loan repayments and is impacted by the principal.

In the example, your principal is the total amount you borrowed, which serves as the base for interest and add-on charges. So, $50,000 is the original amount borrowed, and after your first payments, your reduced principal becomes the actual loan balance you need to pay off.

The overall loan balance usually consists of the principal and additional fees incurred over time. Therefore, loan principal usually differs from loan balance, which is higher because of fees, penalties, interest, and other inclusions.

On the other hand, loan principal and balance can be the same if only the loan interest is added and the payments are made monthly. Like the loan principal, the balance reduces over time as you repay the loan and make monthly payments.

How to Determine Loan Principal

You can check your loan’s monthly statement that mentions the amount breakdown to be paid as well as the amount you owe to the business loan lender. Since each amount is deducted from the principal balance, you can quickly understand your progress with every loan repayment.

If you find determining where your payment per month goes difficult, feel free to ask your lender.

Why Should You Pay Down the Loan Principal As Soon As Possible?

You can pay back your loan principal faster, and the good news is that most lenders allow extra payments for faster loan repayment.

your finances, including how much of the monthly payments go towards the loan principal, how long it takes to pay off your principal, or how much of the monthly payments goes toward the loan interest.

What is the Difference Between Loan Principal and Loan Interest?

Loan interest is a critical factor in determining the amount you need to pay back. However, the loan principal is also crucial when choosing how much you have to repay.

The loan principal is the amount you borrow, while interest is the cost attached to borrowing that money. These figures are added by business lenders, credit unions, or banks to make a profit.

Your loan principal is the dollar amount, while your interest is the percentage. The interest amount you owe depends on the lender’s unique policies and your business credit history. If you have a stronger credit history and higher credit score, it often leads to a lower interest charge. So, it is critical to build good credit before taking out a business loan.

What is the Difference Between Loan Principal and Loan Balance?

Besides loan interest, the loan balance is also essential to loan repayments and is impacted by the principal.

In the example, your principal is the total amount you borrowed, which serves as the base for interest and add-on charges. So, $50,000 is the original amount borrowed, and after your first payments, your reduced principal becomes the actual loan balance you need to pay off.

The overall loan balance usually consists of the principal and additional fees incurred over time. Therefore, loan principal usually differs from loan balance, which is higher because of fees, penalties, interest, and other inclusions.

On the other hand, loan principal and balance can be the same if only the loan interest is added and the payments are made monthly. Like the loan principal, the balance reduces over time as you repay the loan and make monthly payments.

How to Determine Loan Principal

You can check your loan’s monthly statement that mentions the amount breakdown to be paid as well as the amount you owe to the business loan lender. Since each amount is deducted from the principal balance, you can quickly understand your progress with every loan repayment.

If you find determining where your payment per month goes difficult, feel free to ask your lender.

Why Should You Pay Down the Loan Principal As Soon As Possible?

You can pay back your loan principal faster, and the good news is that most lenders allow extra payments for faster loan repayment.

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