What Is Principal Payment?
Definition: Principal payment refers to the payment of a principal amount of a loan, in a bid to reduce the outstanding debt. In this case, payment is made to reduce the amount due on a loan rather than the accumulated interest.
In most cases, individuals and corporations make a minimum payment as agreed in the contractual agreement.
Principal Payment Formula Calculation
When you take a loan, there is usually the principal amount, which is the total amount borrowed as well as the interest, which is the amount you pay for borrowing the amount. Any payments made will, in most cases, go towards settling the principal amount as well as interest incurred over a given period. However, it is possible to designate what the payment made would cater for. In this case, the payment can go towards settling the principal amount and not interest incurred.
In most loan payment structures, there is usually a minimum amount that one is often required to settle on the principal amount, as well as the interest accrued. A borrower, in this case, might decide to pay the principal amount as it affects a great deal the total amount of interest accrued over a given period.
Some borrowers, on the other hand, opt to pay the full principal amount as a way of getting rid of the loan much faster to avoid the risk of incurring more due to interest rates accumulation. It is also common for people to make partial payments that go towards reducing the principal amount, thus reducing the debt outwardly.
How Principal Payments Are Made
Principal payment can be made in a number of ways, all in the effort of reducing the total debt owed. For starters, it can be in partial amounts made on a monthly or quarterly basis catering for the minimum requirement or outwardly full payment that caters for the total amount borrowed less interest incurred.
In addition, a partial payment that also includes interest is also considered a principal payment, as it not only reduces the principal amount but interest fees incurred over a given period.
Principal Payment Example
Consider company XYZ engaged in the production of the car’s spare parts. In a bid to ramp up operations to cater to increasing demand, the company might opt to take out a $3,000 loan. After making some regular months, the loan owed reduces to $2,400.
However, upon considering the amount of money that the business is generating from booming businesses, the manager decides to reduce the debt owed by half. In this case, the manager makes a principal payment of $1,200 that reduces the principal loan amount to $$1,200.
Upon making the principal payment, the business would certainly be able to enjoy low interest on the debt due to it dropping to $1,200 from an initial $3,000.
Benefits of Principal Payments
One of the reasons why most people focus on making principal payments rather than paying off interest is that it goes s along the way in reducing the total debt owed. Likewise, a reduction in the total debt goes a long way in reducing the total interest fees charged, which consequently reduces the total debt owed.
The idea when it comes to loan payments is to ensure interest charges are kept at the bare minimum. This s the only way a business would be able to stay on track in keeping its debt levels low.
Summary
Principal payment in its purest form is simply the making of payments that go towards reducing the amount due on a loan and not the interest incurred. While some payments can help manage the interests charged on a loan, principal payment reduces the debt owed.
Making the principal payment is not as easy as most people might think. Likewise, it is important to contact the lender and find out if it is possible first to settle the principal amount. Some lenders don’t offer the option of making principal-only payments.