In such a schedule, interest payments decrease and payments on the principal increase over time. With a total payment of $1627.45, the unpaid principal balance is only reduced by $1627.45 – $1,000 = $627.45. In the first year, the amount of interest would be $10,000 x 10% = $1,000. This is due to much of the initial total payment going toward paying interest rather than principal. In 10 years, the unpaid balance is $0.Īs opposed to an even principal payment schedule, the amount paid to principal here increases yearly. In the loan repayment schedule above, the loan amortizes over 10 years with even total payments of $1,627.45. The loan repayment schedule would look as follows: Consider John, who takes a $10,000 loan with a 10% annual interest over 10 annual payments. In an even total payment loan, the total payment amount is the same every period. Note that while the payment of principal remains the same, the total payment due each year, including interest, changes. For example, the end of year one interest payment would be $10,000 x 10% = $1,000. The interest payment is calculated on the unpaid balance. Since this amount each year is $1,000, the unpaid balance is reduced by $1,000 yearly. The principal payment each year goes to reducing the unpaid balance. In the loan repayment schedule above, the loan amortizes over 10 years with even principal payments of $1,000. In an even principal payment loan, the principal payment amount is the same every period. There are generally two types of loan repayment schedules: The principal payment goes to reducing the outstanding principal amount due, while the interest payment goes to paying the fee to borrow the money. The individual in the situation above would need to make an annual total payment that consists of both principal and interest payments. A bank may require 5% annual interest on the principal amount – the fee paid to borrow the money. The $600,000 is the principal amount – the money borrowed. They would need to borrow $600,000 from the bank to complete the transaction. The principal is the amount borrowed, while the interest is the fee paid to borrow the money.Ĭonsider an individual who saved $400,000 to pay for a $1,000,000 home. Every loan comprises two components – the principal and the interest. Understanding the components of a loan is very important. In accounting and finance, a principal payment applies to any payment that reduces the amount due on a loan.īond Principals are further analyzed on CFI’s Fixed Income Fundamentals Course. In other words, a principal payment is a payment made on a loan that reduces the remaining loan amount due, rather than applying to the payment of interest charged on the loan. A principal payment is a payment toward the original amount of a loan that is owed.
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