Principal repayment is a payment towards the outstanding capital of a loan. This is also known as a capital repayment. A principal repayment (as it is called in the US and Australia), or capital repayment as it is often referred to in the UK is any payment that reduces the amount that you borrow, rather than simply paying interest charges.
Principal repayments are required as they are the only way of repaying your loan balance and therefore reducing, or even totally ending your interest charges.
Most personal loans allow unlimited additional principal payments, known as overpayments. This allows you to repay your loan early and can lead to significant interest savings.
What is an additional principal payment?
Additional principal payments, known as overpayments in the UK refer to any payment which is greater than, or paid in addition to your agreed monthly payments. Overpayments allow you to reduce either your monthly payments or the loan term. Either option will reduce the interest portion of your loan – the amount of interest due on your loan balance. The principal payment calculation of which option is best for you depends on your monthly budget and your desire to reduce the total amount of interest paid.
Choosing to reduce your loan term – the amount of time remaining on your loan will provide the biggest interest savings and will see your monthly payments remain the same as they were pre overpayment.
Principal only payments are payments that go only towards repaying the loan balance. As overpayments are additional payments, they are a form of principal-only payment, whereas regular monthly payments are made up of both interest and capital repayments.
What is the example of principal payment?
For a personal loan with an outstanding balance of £10,000, an interest rate of 7.99% and a remaining term of 5 years, the monthly payments would be £202.72 per month. By paying each monthly repayment on time, the total interest due is £2,162.87 without overpayments. By paying a lump sum overpayment of £2,000, you would save £833 in interest and by keeping your monthly repayments at £202.72 you would repay your loan 1 year and 1 month early.
It’s not simple to calculate principal payment benefits without using a tool due to the compound interest applied to capital repayment loans.
What is the connection of Principal Payment to Amortization Schedule?
Principal payments reduce your loan balance and therefore change your amortisation schedule, by allowing you to either repay your loan early, or reduce your monthly repayments.
To understand this fully, we first need to look at the loan amortisation definition. An amortised loan are loans that see their principal reduce over the full term through the monthly repayments.
Loan amortisation is intrinsically connected to principal payments, as whenever you make a principal payment on your loan, you must consider the most beneficial way to handle your future amortisation schedule – the term of your loan. Reducing the loan term and keeping your repayments the same will see the amount of interest you pay reduce the most. Sticking to the same term will reduce your monthly payments, but will see your total interest reduce by less than would be the case when reducing the term.
What is the connection of principal payment to a car loan calculation?
Car loan calculators allow you to calculate your monthly payments based on your loan amount, loan term and interest rate. Some car loan calculators also calculate the total amount of interest as well as your amortisation schedule, this depends on the car loan calculator used.
As mentioned above, principal payments impact this and will change both the amount of interest due and in many cases, your monthly payments.
For example, a car loan of £10,000 over 5 years at an interest rate of 7.9%. This loan would see the borrower pay total interest of £3,206 and have monthly payments of £303.46.
Should the borrower make an overpayment of £3,000 in month 25, they will see their outstanding balance reduce by the overpayment amount and their loan will now be repaid in 24 months. This would save the borrower £681 in interest over the remaining loan term.
What is the connection of Principal Payment to Mortgage Calculation?
Mortgage calculators allow you to calculate your monthly payments and total interest due, based on your outstanding mortgage balance, interest rate and term. While it can be very beneficial, many borrowers are confused and ask how can they use overpayments for their mortgage?
Principal payments, known as overpayments are how you pay down your principal faster than would be the case should you choose to pay only the contracted monthly payments.
What is the difference between principal and interest?
Principal refers to the balance of your loan or mortgage and is the amount of money that you owe to your lender. Interest is the charge levied against that outstanding balance for lending you the money. While many think of this as principal vs interest, they are inherently connected and any change in the principal amount will immediately change your interest charge.