Q

What is principal?

A

The amount of money that's borrowed or invested initially.

The word “principal” literally means primary, or main, but will refer to different things in different contexts. If you are 7 years-old and have come upon this page after frantically Googling to get the lowdown on the adult who’s just summoned you to her office, fear not—elementary school principals are no longer allowed to spank kids. Even in the financial world, “principal” can mean several things, such as an owner of a private business, the amount a bond pays upon maturing, or the person who has the right to make financial transactions on behalf of a business or organization.

But principal is most commonly used to refer to the amount of money that is taken out as a loan, or initially put into an investment. In the context of real estate, the principal is the amount of money you need to pay in full, plus interest, in order to own a home outright. Throughout the life of a mortgage, the principal amount will gradually decrease. For this reason, with, there’s a seesaw effect over the life of a mortgage with regards to how much of the monthly payment goes towards the principal versus interest. In the early days of the loan, almost the entire monthly payment will go towards interest, but as the loan heads towards maturity, a larger and larger percentage of the payment will go towards the principal. This is because interest is only charged on the principal, so the less principal that remains, the less interest you’ll owe. By the end of the loan term, the principal will be so reduced that only a very tiny portion of the payment will be required to pay the interest—further reducing the principal (and naturally lowering the amount of interest owed.)

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