What Is a Loan Principal and Why Is It Important?

Before applying for a loan, it is critical to understand the financial jargons that defines the terms and conditions of your loan. It tells you how much your total borrowing costs you and how much you must pay each month to meet your monthly obligations. The most commonly heard terminology in a loan is the principal amount.
 

What is the Principal amount in a loan?

 
The loan principal is the actual amount you have borrowed from a financial institution to meet your funding needs. It is the loan amount sanctioned by the lender. Once the funds are disbursed, you need to repay this amount in the form of EMI (equated monthly instalments). Your EMI would consist the interest and a portion of the original loan amount.
 
Let’s understand this with an example -
 
Suppose you availed a loan of Rs 1, 00,000 with a 14% interest rate for three years. The expected EMI here is Rs 3,418, and the total amount you will pay after three years is Rs 1,23,039.
 
At the beginning your principal outstanding is Rs. 1,23,039. As you go on paying your EMI every month, this principal outstanding would also go on decreasing. Even though the loan amount is Rs 1,00,000, an additional Rs 23,039 is paid in interest.
 

What is the principal outstanding on a personal loan?

The outstanding amount is the portion of the principal loan amount plus the interest rate that you still owe. Assume you took out an Rs 80,000 bike loan with a 10% interest rate over a 4-year term. Your monthly EMI will be Rs 2,029 in this case. If you have made regular EMI payments for the past 24 months, your outstanding balance, including interest, will be Rs 48,696 (Rs 2,029 × 24 months).
 

What is the interest on the principal amount?

Banks and other financial institutes offer you customized loans for a specific amount that they charge as interest on the loan. This is their returns on investment that they made on you. This interest accommodates the cost of borrowing and is determined after a thorough examination of your income, existing debt obligations, age, and other factors.
 
The interest rate on your loan can vary from lender to lender and borrower to borrower. RBI sets a minimum interest rate known as the repo rate. Banks treat as the base rate. In addition to this base rate, the interest rate consist complex calculations to accommodate operational costs, and profit margin. Financial institutes also balances their risk margin by adjust the interest rate.
 

How can you clear your Principal repayment faster?

 
There are numerous ways to repay your debt faster. The tried and tested ones are listed below.
 

1. Increase the down payment

   This concept applies to loans in which the asset is hypothecated with the lender. For example, if you are looking for a car loan or bike loan increasing your down payment will reduce your principal borrowing while also lowering your EMIs. As a result, when the EMI is affordable, making partial prepayments for early loan closure is simple. 



2. Make partial prepayment

   Paying several months' EMI in one month is known as partial prepayment. People often use this approach when they have received handsome increments in the office or have earned windfall income. However, keep in mind that partial prepayment carries a small penalty that the lender charges to compensate for the lost interest income.
    
   You don't have to worry about these fees if you have a home loan with a floating interest rate. You can choose partial or complete pre-closure of the loan without incurring additional fees. Make sure to ask your lender about fixed interest rates and floating interest rates before availing the loan.
    

3. Shorter tenure

   There are two advantages to choosing a short tenure. First, you can pay off your loan sooner, and second, you avoid paying a higher interest amount. You can use an online EMI calculator to decide on the optimal loan tenure. It is an online tool available on every lender's website that allows you to experiment with different loan component variables until you reach the desired figure.



4. Add co-applicant

   If you believe managing debt alone is a tough task, you can always borrow with a co-applicant. The co-applicant can be anyone in your close relationship. Suppose you require a Rs 20,00,000 business loan but believe you will be unable to manage repayment on your own. You can submit an application with your business partner as a co-applicant. The EMI will be split evenly between you two, in this case, allowing for faster principal repayment.
    

5. Balance transfer

   You can consider transferring the outstanding balance of your existing loan to a new lender if you believe the new lender will offer you better repayment terms and lower interest rates. If the new lender accepts your request and lowers the interest rate, your EMI will be reduced automatically, allowing you to repay the principal faster.
    

6. Consider APR

   Examine the APR when reviewing the loan agreement. APR stands for annual percentage rate and refers to the various charges associated with your debt. Some of these charges are processing fees, documentation charges, and a few situation-based costs like rescheduling fees. All of these factors have a significant impact on your payments and may cause the principal repayment to stretch.

 
Also Read: Top 26 Personal Loan Terminologies to Know
 

Conclusion

 
The principal amount represents the sum you originally borrowed from your lender. The principal amount is specified in the loan agreement. You can also calculate the outstanding principal and interest by using an amortisation calculator or contacting your lender's executive.