What is a loan principal?

When you take out a loan, or use a credit card, you have to be aware of two amounts of money: The principal, and the interest. Knowing which is which, and what they mean, is crucial.

The loan principal, or the principal balance, is the amount you have taken on. That is: If you take out a loan for $5,000, or rack up that much in credit card debt, your principal is $5,000. Anything added to that amount is as a result of interest. So if you pay $400 in your first month after taking on that debt, that money would cover both the interest added to it (say, $25 based on high annual rate) and the principal.

That means that you reduced your principal by $375, even if you paid $400. But as your principal drops, so too will the size of your interest charges, adding to the value of each successive payment when it comes to reducing that principal.

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