What is a Loan Principal?

What is a Loan Principal?

Definition

The loan principal is the amount that has been lent to the borrower. If a company applies to a bank for a loan and receives a sum of, say, $1 million, then this initial amount is referred to as the loan principal.

The term could also apply to the amount that remains outstanding on a loan. So, for example, if you borrow $20,000 and repay $5,000 of this amount, the remaining $15,000 will be referred to as the loan principal that remains outstanding.  

What does loan principal mean?

The sum that a lender advances to a borrower is the loan principal. This amount would usually need to be repaid along with interest. Every repayment that is made would typically include interest as well as the principal. But only the latter would go to reduce the loan principal.

The method described above is one way in which a loan could be structured. A car loan or a loan for purchasing residential property usually require monthly repayments of principal and interest. Consequently, the loan principal outstanding gradually gets reduced.

But a loan could be structured in another manner. The lender may require a “bullet” repayment at the end of the loan term. What this means is that the borrower would pay interest for the number of months or years for which the loan has been provided. The entire principal would be repaid at the end of the loan term in a lump sum.  

Example of loan principal

Alex Glover, a building material supplier, approaches a bank for a working capital loan of $100,000. The loan is approved on the condition that Alex furnishes a personal guarantee. The interest rate is 8% per year and repayment is to be made in a bullet payment at the end of 18 months.

Alex decides to take the loan, as he is confident that he can repay. He is expecting some large payments from some of his customers over the next six to 12 months. In the meantime, he can easily afford to pay the monthly interest of $667.

Eighteen months later, Alex has paid $12,000 as interest. He also repays the entire loan principal of $100,000 to the bank and closes the loan account.  

Summary

Loan principal refers to the initial amount that the lender provides to the borrower. It can also mean the amount that is outstanding against the principal on a loan that was taken at an earlier date.