Principal

What Is A Principal?

The term “principal” refers to different things in the finance world. In the context of investing, it refers to the original amount committed to investment. In the context of borrowing, it relates to the actual amount you borrowed before interest accrued.

Deeper Definition

In the financial world, the term “principal” has different meanings. However, most people use it in terms of the meaning of investing and borrowing. In investing, the principal is an amount a person puts into an investment. In borrowing, a principal is the original loan amount you obtained, excluding any interest that accumulates on it over time.

When used to refer to an investment, a principal is an original amount upon which interest accrues. Investing entails allocating resources, usually money, with the expectation of generating an income or profit in the future. It is a reliable way to build wealth over time. Regardless of the kind, all investments require that you sacrifice some asset you currently own, such as time, money, or effort. Whatever you put down to begin an investment is your principal. If the investment is successful, it will accrue interest on your principal, known as returns. The returns you make on investment depend on your principal amount; usually, it is a percentage of the amount. For instance, if you invest $100 and earn a 10% interest, you get $10 plus your $100. 

When individuals or businesses borrow money, they often promise to pay the borrowed amount with an additional amount. The actual sum of money borrowed by a company or individual is the principal, while the other fees are the interest. The principal often determines the amount of interest an entity pays on a loan because lenders usually charge a percentage of the principal as interest. For instance, if you take a loan of $1,000 with a fixed interest rate of 5%, you will pay $1,000, which is the principal, plus $50, which is the interest.

Principal Example

Michael wants to start a new business but does not have enough money to execute the plan. He approaches a bank and takes a $10,000 loan with an interest rate of 19.5%. He adds $5,000 from his savings to the loan and uses a total of $15,000 to start the new business. In borrowing, $10,000 is the principal amount, while $15,000 is the principal amount in investing.