What is the difference between principal and balance?

The principal is the original amount of money borrowed or the remaining amount of that original sum, excluding interest and fees. The balance, on the other hand, is the total amount currently owed, which includes the outstanding principal, any accrued interest, and sometimes fees. As you make payments, both the principal and the balance decrease, but the balance always reflects the full amount due at any given time.

Does paying extra on principal save money?

Yes, absolutely. Paying extra on the principal balance of a loan directly reduces the amount on which interest is calculated. This means you will pay less interest over the life of the loan and pay off your debt faster. The earlier you make extra principal payments, the more significant the interest savings will be due to the power of compounding.

How do I know how much of my payment goes to principal?

For amortized loans like mortgages or auto loans, your loan statement will typically show the breakdown of your payment between principal and interest. You can also use an amortization schedule, which details this allocation for every payment throughout the loan term. Early in a loan, more goes to interest; later, more goes to principal.

Can I pay off principal only?

Yes, you can often make payments that are designated solely for principal. When making an extra payment, it's crucial to specify to your lender that the additional amount should be applied directly to the principal balance, not as an advance on future payments or to cover accrued interest. This ensures the payment immediately reduces your core debt.

What happens if I don't pay my principal?

If you don't make payments on your principal (and therefore your overall loan balance), you will default on your loan. This can lead to severe consequences, including late fees, damage to your credit score, collection efforts, wage garnishment, and potentially the seizure of collateral (like a home or car) if the loan is secured. Unpaid interest will also continue to accrue, increasing your total debt burden.

Is it better to pay off principal or invest?

This depends on your specific financial situation, debt interest rates, and investment returns. Generally, if your debt has a high interest rate (e.g., credit card debt at 18%+), paying off the principal is often the better choice, as the guaranteed "return" (interest saved) usually outweighs potential investment returns. For lower-interest debt (e.g., a mortgage at 4%), investing might be more beneficial if you expect higher returns from your investments. It's a personal decision often best made with the help of a financial advisor.

How does principal capitalization work with student loans?

Principal capitalization occurs when unpaid interest is added to your outstanding student loan principal balance. This increases the total amount you owe, and from that point forward, interest will be calculated on the new, larger principal balance. This often happens after a grace period ends or if you defer payments without paying the interest. It's crucial to avoid capitalization where possible, as it makes your loan more expensive over time.

Principal in Debt: Your Complete Guide | One Percent Finance