Last editedAug 20202 min read
Loans can be used for all sorts of things in the world of business, from bankrolling your company’s expansion plans to funding a new product line. But where there’s a loan, there’s debt.
While no-one enjoys making loan repayments, understanding how your repayment schedule works is crucial for business owners everywhere. As such, it’s important to have a comprehensive understanding of principal payments and how to calculate the amount you owe. So, what is the principal payment? Get the lowdown on everything you need to know with our simple guide.
What is the principal payment?
There are two basic components of a loan: the principal and the interest. So, what is the principal and interest payment? Essentially, a principal payment is a payment that goes toward the repayment of the original amount of money borrowed in a loan. Interest, on the other hand, is a fee you pay to borrow the funds, typically calculated as an annual percentage of the loan. So, when you make a principal payment, you’re reducing the amount of loan that you’re due to pay back, but not the amount of interest that’s charged on that loan.
Understanding scheduled principal payments
Now that you have a basic understanding of principal payments, it’s important to delve into the mechanics of how they work. When making repayments on a loan, there are two basic options:
Even principal payments – With an even principal payment loan, the principal payments will be the same in every period. For example, if you have a $20,000 loan that amortises over the course of 10 years, the principal payments will amount to $2,000 each year, with no variation.
Even total payments – When it comes to even total payments, the total payment amount is the same in every period, but the principal will differ. With these types of loans, the principal payment usually increases over time, while the amount of interest decreases.
Although lower principal payments at the beginning of your loan repayments may look like an attractive option, making equal principal payments throughout the term of your repayment schedule could actually yield lower interest rates, meaning that you’ll end up paying a lower amount than you would with an even total payments schedule.
Calculating your business’s monthly principal payments
If your business is dealing with loan repayments, understanding how to calculate your principal is likely to be beneficial. After all, according to a study we conducted, 21% of borrowers say that not knowing how much they need to pay is the most likely cause of their missed payments. So, how do you calculate your scheduled principal payments?
There’s a relatively complicated formula you can use, which is as follows:
a / {[(1+r)^n]-1]} / [r(1+r)^n] = p
Note: a = total loan amount, r = periodic interest rate, n = total number of payment periods, p = monthly payment).
If you’re looking for an easier way to work out your principal payments, a principal payment calculator may be the way to go.
Online principal payment calculators
With a few pieces of basic information about your loan, such as the initial loan amount, the interest rate, the payment frequency, and so on, you can find out the full purchase cost, total interest, and more using a principal payment calculator. There are many different options available online, but to get started, why not check out Calculator.me’s principal payment calculator.
We can help
GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.