Principal, in the context of debt financing, is the initial amount of money that is borrowed in a loan. Once paid down over the course of the loan’s term through debt service payments, principal can then be referred to the amount that is still owed on the loan. The amount of interest and amortization paid annually, assuming it is not an interest-only loan, is a function of the loan’s principal amount.
For example, if you borrow $100,000 for a real estate investment, the principal is $100,000. At a 5% interest rate, that’s equal to about $5,000 per year in interest. If you pay down $40,000 on this loan, the remaining principal is $60,000. Interest on the $60,000 balance will be $3,000 per year at 5% interest.
Payments on a mortgage are generally made monthly. Part of the payment goes toward principal and part toward accrued interest. For example, if the monthly payment is $600 and interest is $250 for the month. The interest is first paid and the remaining $350 goes toward the loan principal. In this case, the $60,000 loan will be reduced to $59,650. Interest is then charged on the new principal amount of $59,650.
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