What is the Principal Amount on a Home Loan?

When you apply for a home loan, there are several financial terms you may come across that have confusing meanings in the beginning. The "principal amount" will be one of the most important terms you will ever come across. In this blog, we will explain what a principal amount is in a home loan, why it matters, and how it would impact your loan repayment. 

What is Principal Amount?

The principal amount on a home loan refers to the original sum borrowed from a lender, excluding the interest.  This amount forms the basis of your loan agreement and influences your monthly repayments. As you make repayments, a portion goes towards reducing this principal, ultimately impacting the total interest paid over the loan’s duration and the length of the repayment term. Be it a housing loan or any other kind of loan, this is the amount against which one owes it and must return during the tenure of the loan.

How Does the Principal Amount Work?

The principal amount of a home loan remains the same unless you repay a part of it. Every time you make a repayment, you reduce the size of that principal, which is still outstanding to be repaid. But in the initial years of your loan, a major portion of your monthly installment-usually known as the EMI-is used to service interest on the loan. A fraction of the EMI is for setting off the principal amount. As time progresses and the loan approaches maturity, your EMI starts covering a larger share of principal repayment.

What is the Principal in a Loan?

The 'principal,' in any loan-be it your home loan or a personal loan- refers to the original amount of money you borrow. It is the basis upon which your entire loan repayment schedule is founded. The amount of interest you pay over the life of the loan depends upon the outstanding value of the principal and the rate of interest you are being charged.

Housing Loan Principal Repayment

Regarding the home loan principal repayment, each one of your regular repayments gets divided into two components: 

• Principal repayment
• Interest payment

Every month, the amount you pay towards the principal repayment is the amount to be utilised for decreasing the principal outstanding amount. At the beginning of your home loan, high interest and low repayment in the principal occur. As you go into the payments, it decreases while the repayment in the principal increases as time goes on.

Importance of Reduction of Principal Amount

The faster you pay down your home loan principal amount, the less interest you will eventually pay. That is because interests are calculated on the outstanding principal. If you make extra payments towards the principal, better known as prepayment, you can reduce your total interest burden and pay off your loan earlier.

How to Bring Down the Principal Amount Faster

The bottom line to getting relief from the interest burden is to reduce the principal as soon as possible. Here are ways of doing it:

• Pre-payments: You can make the payment in addition to the normal payment anytime when you have surplus money. It reduces the outstanding principal and reduces overall interest.
• Increase EMI payments: Pay a little more amount as EMI, which will help return the principal amount as early as possible and hence reduce the overall interest amount paid on your loan.
• Shorten the loan tenure: Though opting for reduced tenure will increase the EMI amount, it helps to reduce the outstanding principal amount faster. As a result, huge interest savings can be generated from this.

Impact of Principal Amount on Loan Repayment

The principal amount borrowed from a lender directly impacts monthly EMI, total interest payable, and repayment duration. A larger principal amount leads to higher EMIs and longer repayment periods, while a smaller principal allows faster repayment with less interest. For example, borrowing ₹40,00,000 at an 8% interest rate for 20 years will result in higher monthly EMIs and higher total interest due to the higher principal.

Principal Amount-Interest Rate Relationship

The outstanding balance and the rate of interest operate in relation to each other in a home loan. The interest that you pay is always on the outstanding principal amount. So, if you reduce the principal amount by making extra repayments, you reduce the amount of interest you have to pay.

Home Loan Principal Repayment Strategies

Some of the ways by which you can manage the home loan principal repayment of your housing loan include the following:

• Early pre-payments: If you make pre-payments during the initial years of your loan, it will drastically cut down the outstanding principal amount, thereby reducing your interest burden.
• Increase the frequency of payments: You can try to pay bi-weekly if possible, instead of paying monthly. This way, you end up making an extra payment each year and bring down the principal quantity faster.
• Lump sum payments: Bonuses, tax refunds, or any other windfalls may be diverted to the principal in the form of lump sum payments. Additional loan payments can save extra dollars in interest charges and, arguably, complete the loan in advance.

Conclusion

The principal amount in a home loan is a crucial factor in determining repayment per payment and is directly related to interest paid and loan tenure. Understanding the principal and reducing it through prepayment or increased monthly EMI payments can help save money on interest and pay off the loan more quickly. Whether a new home loan or improving an existing one, understanding the principal amount helps make informed decisions about loan repayments.

FAQs

1. What is the principal amount in a home loan?

The principal amount in a home loan is the original sum of money you borrow from the lender.

2. What is the meaning of principal in a loan?

The principal refers to the actual amount of money borrowed, excluding the interest.

3. How does the home loan principal repayment work?

Principal repayment in a home loan would essentially imply reducing the amount owed, or in other words, more of your EMI would go towards the principal as time progresses.

4. How can I reduce the principal amount of a home loan faster?

You can reduce the principal by making extra payments or increasing your EMI to repay the loan quickly.

5. What happens when the housing loan principal is reduced?

As the housing loan principal reduces, you pay less interest because interest is charged on the outstanding principal.