The amount borrowed or lent in the form of debt is referred to as ‘Principal’. In the case of a loan, the principal would be the amount owed by the lender to the borrower. In the case of a bond, debenture or other form of debt instrument, principal is the face value of the instrument.
The Importance of Principal
This is the amount that has to be repaid by the Borrower on the contracted terms; either in instalments or as a bullet repayment on the due date. It determines the return for the investor and the liability for the borrower. Principal is the sum on which interest is calculated.
In a debt account, Principal is important because during the period that the principal or any part of it remains outstanding, the Borrower has to pay and the lender is entitled to collect interest. Interest is calculated on the amount of principal that is outstanding. The larger the amount outstanding, the greater the amount of interest that is payable. The figure is also dynamic. Every time an instalment is repaid, the amount of principal and consequently, the interest payable reduces. Therefore, a borrower who wishes to reduce his interest burden must pay back the principal as early as possible.
Paying back you principal amount sounds easy, but is easier if you make more than the minimum repayment every period. The more you pay back, and the higher your repayments (higher than the minimum required repayment), the less interest you will have in the long run. Interest is the real killer in loaning money, not the principal amount.