Principal Balance

Principal Balance refers to the amount owed on a debt, whether it is the original face amount or the remaining unpaid debt on a loan that has been partially amortized.

Examples

Example 1: If you take out a car loan for $15,000 and make a payment where $400 goes towards the principal and the rest towards interest, your new principal balance would be reduced to $14,600 after the payment.
Example 2: A homeowner with an initial mortgage principal of $200,000 who has made several payments reducing the principal to $180,000 would have a remaining principal balance of $180,000.

Frequently Asked Questions

Q1: How is principal balance different from loan balance?

A: The principal balance is specifically the amount of the loan that needs to be repaid, excluding interest. The loan balance includes both the principal and any accrued interest that is yet to be paid.

Q2: Does paying more towards the principal balance reduce my loan term?

A: Yes, making additional payments towards the principal balance can reduce the overall term of the loan and the total interest paid over the life of the loan.

Q3: When making a loan payment, how is the payment applied?

A: Loan payments are typically applied first to any outstanding interest and fees, and then to the principal balance.

Q4: Can the principal balance go up instead of down?

A: Yes, in cases where accrued interest or fees are capitalized (added to the principal), or if payments are insufficient to cover the interest, the principal balance can increase.

Q5: Why is my initial loan statement different from future statements regarding principal balance?

A: Initial loan statements may show the original principal amount and projected schedules, while future statements reflect changes due to payments made and interest accrued, showing a reduced or updated principal balance.

Debt: An obligation that requires one party to pay money to another party.
Amortization: The scheduling of loan repayments over time, where each payment reduces the principal amount owed and also covers interest.
Face Amount: The original sum of money borrowed through a loan or by issuing a bond, excluding interest.
Interest: The cost of borrowing money, typically a percentage of the unpaid principal balance.

Online Resources

References

“The Intelligent Guide To Real Estate Investing” by Eliza Cross and Sara Lomax
“Real Estate Finance and Investments” by William Brueggeman and Jeffrey Fisher
“Your Money And Your Brain: How The New Science of Neuroeconomics Can Help Make You Rich” by Jason Zweig

Suggested Books for Further Studies

“Rich Dad Poor Dad” by Robert T. Kiyosaki
“The Book on Rental Property Investing” by Brandon Turner
“Investing in Real Estate” by Gary W. Eldred
“The Millionaire Real Estate Investor” by Gary Keller

Real Estate Basics: Principal Balance Fundamentals Quiz

### When talking about a loan, what does the principal balance refer to? - [ ] The total interest paid on the loan. - [x] The remaining unpaid amount of the loan itself, not including interest. - [ ] The starting balance plus one year of interest. - [ ] The service fees and interest or fines. > **Explanation:** The principal balance refers specifically to the amount of the loan or debt that remains unpaid, excluding any interest that has accrued. ### When you make a loan payment, how is it typically applied? - [ ] Entirely to the interest first. - [ ] Entirely to the principal balance. - [x] First to any outstanding interest and fees, then to the principal balance. - [ ] Equally to interest and principal balance. > **Explanation:** Loan payments usually are applied first to any accrued interest and fees, and the remaining amount then goes towards reducing the principal balance. ### How can making extra payments on the principal affect the loan? - [ ] It can extend the loan term. - [ ] It only impacts the interest schedule. - [x] It can reduce the overall loan term and total interest paid. - [ ] It will increase the overall loan balance. > **Explanation:** Additional principal payments directly reduce the principal balance, potentially shortening the loan term and decreasing the total amount of interest paid over the life of the loan. ### True or False: The principal balance includes the accrued interest and fees. - [ ] True - [x] False > **Explanation:** False. The principal balance consists only of the unpaid amount of the loan itself, excluding any accrued interest, fees, or other charges. ### Can the principal balance of a loan increase over time, and if yes, how? - [x] Yes, through capitalized interest and fees. - [ ] No, it only decreases. - [ ] Yes, by making on-time payments. - [ ] No, it is fixed once the loan is disbursed. > **Explanation:** The principal balance can increase if interest or fees are added to the principal through mechanisms like capitalized interest, where unpaid interest is added to the outstanding principal balance. ### What is amortization in the context of loans? - [ ] The depreciation of tax obligations. - [x] The process of gradually reducing the loan principal through scheduled payments. - [ ] The increase of interest rates over time. - [ ] None of the above. > **Explanation:** Amortization refers to the process of gradually paying off the principal balance of a loan over time through regular, scheduled payments that also cover accrued interest. ### When making monthly payments, why might they seem the same if both interest and principal are being paid? - [ ] Since the principal doesn't change. - [ ] Because only the interest rate matters. - [x] Because payments are structured to ensure a mix of principal and interest is paid off each month. - [ ] Due to fixed fees and charges. > **Explanation:** Payments are structured in a way that a portion of each monthly payment applies to reducing both the principal balance and interest, keeping the monthly payment relatively unchanged despite shifts in amounts applied towards principal and interest as the loan amortizes. ### What's the primary financial benefit of paying down the principal balance faster than scheduled? - [ ] Higher monthly payments. - [ ] Higher interest accumulation. - [x] Reducing the overall interest paid and potentially paying off the loan early. - [ ] Higher administrative fees. > **Explanation:** By reducing the outstanding principal balance faster, borrowers can decrease the total amount of interest that accrues, potentially allowing them to pay off the loan sooner. ### How is the initial loan statement different from future statements regarding the principal balance? - [x] Initial statements show the original principal amount, while future ones reflect current reduced balances. - [ ] Initial ones include interest accrued. - [ ] No difference. - [ ] Initial statements account for lower repayments. > **Explanation:** Initial loan statements generally show the full principal amount at the start of the loan term. Over time, future statements reflect reductions to the principal balance owing to ongoing payments. ### Who benefits best from understanding principal balance? - [x] Borrowers who want to manage their debt efficiently. - [ ] Only lenders. - [ ] Real estate agents. - [ ] Consumers only concerned with interest rates. > **Explanation:** Borrowers benefit most from understanding the principal balance as it allows them to manage and strategically pay down their loans more effectively, potentially saving on overall interest and reducing debt more quickly.

Principal Balance