When you take out a loan, there’s a lot of important information that can be confusing. One thing you’ll want to know is the loan principal and how it affects your overall balance. In this article, you’ll go over what loan principal means and why it matters for businesses or individuals borrowing money.
As per financial experts like Lantern by SoFi, “Compared to other forms of financing, like credit cards or a business line of credit, SBA loans may offer more favorable terms, rates, and down payments for qualified borrowers.”
Loan Principal Definition
Loan principal is the amount of money that you borrow from a lender to purchase a home, car, boat or other assets. Principal is also known as “loan balance” and represents the portion of your loan not including any interest. In other words, it’s the non-interest amount you are obligated to pay back over time.
How Does a Business Loan Principal Work?
When you take out a loan, the amount that you borrowed is known as the principal. This is also the amount that will be paid back over time as well as interest on top of it. It’s also necessary to know how do sba loans work?
The principal can be broken down into several parts including:
- It’s the initial loan from your lender.
- The monthly payments made to pay off this principal (along with interest).
- It’s what you owe at any given moment in time.
How to Determine Your Loan Principal
The loan principal is not synonymous with the interest rate. A loan with a high-interest rate may have a lower monthly payment because of it, but you will still have to pay back more money than your original loan amount.
For example, if you borrow $100 at half-percent interest over one year ($5/month), you will owe $105 after twelve months—the original principal plus accrued interest. On the other hand, consider an annual percentage rate (APR) of 5% for an auto loan for two years at $200 per month with no down payment: This comes out to be about $2,000 in total payments.
However, if you paid off your car within 18 months instead of 24 months as originally planned because of lower monthly rates on another vehicle purchased instead of buying new ones…well then now you’re talking about making money!
How Do Loan Principal Affect Taxes?
The amount of taxes you pay on the principal depends on how your lender calculates them.
- Monthly: In this, your lender will calculate the interest and principal for each month individually. This means that if you’ve paid off some of your loan balance, there may be times when more of your payment goes toward principal than it did before (or vice versa).
- Annual: If you pay taxes in annual installments, all of those payments go toward paying down the original loan amount. As a result, at any point after receiving a tax refund from one year’s return filing date until two years later when filing again for another year’s refund would mean no money coming back to you after sending out all those checks.
- Interest Only: In this, taxes are calculated on only what is owed in terms of interest before applying any additional amounts paid toward reducing principal balances through additional payments made during regular monthly periods within each given year’s periodic cycle (January through December).
If you’re looking for a loan to help grow your business, make sure to understand how loan principal works and how it can affect your taxes.
