Principal vs. interest: What’s the difference?
When it comes to loans, you’ll generally have to make minimum monthly payments. Part of each payment typically goes toward paying off the interest that’s accrued since your last payment.
And if the payment is for more than the interest, the remainder will pay down your account’s principal balance. Understanding how the principal balance and interest differ and interact can be helpful when you’re managing debt.
Key takeaways
-
The principal balance on the loan is generally how much you borrowed and still owe.
-
Interest accrues on the principal based on the account’s terms and its interest rate, which is the cost of borrowing money.
-
Monthly payments generally get split between the interest that accrued since previous payments and the principal balance.
-
You can limit or avoid interest charges on a credit card by paying your statement balance in full every month.
What is loan principal?
A loan’s principal balance is generally the amount originally borrowed. The principal balance is important because the loan’s interest rate typically applies to the principal balance. So how much interest accrues can depend on both a loan’s interest rate and the remaining principal balance.
What is an interest rate?
In general, interest is the price of borrowing money. An interest rate determines how much interest a creditor charges on the amount of money borrowed.
Here’s a basic example: Say you borrow $100 and the loan has a 10% interest rate. That means you’ll have to pay $10 in interest over the first year.
But many loans and credit cards advertise an annual percentage rate (APR) rather than an interest rate. The APR is the annualized cost of borrowing, including certain fees. With loans, the APR may be higher than the interest rate if the lender charges upfront fees.
With credit cards, the APR and interest rate are often the same. But neither includes certain avoidable credit card fees.
The interest rate, and the resulting APR, on a new account can depend on creditworthiness, the lender and the specifics of the loan or credit card.
How to calculate the interest and principal on your loan
You could try to calculate how much interest accrues on your loan each day or month by hand. Using an online calculator might be an option too. You could also try to calculate APR based on the interest rate and fees. But the Truth in Lending Act (TILA) also requires lenders to disclose a loan’s APR.
An easier option could be looking at a recent statement. It could tell you how much of your payment went toward interest and how much went toward the principal balance.
And if you’re comparing loan offers, lenders may show you an amortization table that shows how every monthly payment will get split between principal and interest over the loan’s term.
How interest and principal amounts impact your monthly payment
Your monthly payments go toward your principal balance and interest and fees that have accrued since your last payment. But several factors can affect how much interest accrues and your resulting monthly payment.
-
Simple vs. compound interest: Many loans use simple interest, meaning the interest rate only applies to the remaining principal balance. But some loans use compound interest that can apply to the principal balance and outstanding interest.
-
Fixed vs. variable rates: If an account has a fixed interest rate, the rate stays the same for the lifetime of the loan. When accounts have variable interest rates, the rate can change and affect your monthly payment.
- How often interest accrues: Interest generally accumulates on a daily or monthly basis. The more frequently it accrues, the bigger the impact on your monthly payment.
Revolving credit vs. installment loans
Monthly payments often work differently for loans and credit cards.
-
Monthly payments for loans: Many loans are amortized, and the monthly payment stays the same if the loan has a fixed interest rate. A portion of each payment goes toward paying down the interest, and the remainder pays down the principal balance. As the principal balance decreases, less interest accrues and a larger portion of each payment goes toward the principal balance.
- Monthly payments for credit cards: Credit cards generally use compound interest, and the interest compounds daily. Your monthly payment can depend on whether you previously revolved a balance, how much you’ve spent during the recent billing cycle and other fees, payments or transactions. You can make minimum monthly payments. But many credit cards also have a grace period, and your purchases won’t accrue interest if you pay your credit card balance in full each month instead.
What you can do if your principal and interest payments feel too high
There are many strategies for managing debt. Some might help you save money. Others might decrease your payments today but wind up costing you more overall. It might help to consider which option, or options, will be best based on your goals and finances.
Consolidate debt
You might be able to take out a new loan and use the proceeds to pay off several other loans or credit cards.
Debt consolidation doesn’t decrease how much you owe, and some loans may have origination fees that can increase your total debt. But if your new loan has a lower interest rate than your current debts, your debt could accrue less interest each month. And the monthly payment on your loan might be lower than the combined minimum monthly payments on existing debts.
Many people use an unsecured personal loan to consolidate their debts, and that loan sometimes gets called a debt consolidation loan.
Apply for a balance transfer
Some credit cards offer introductory or promotional APRs on balance transfers, which you can use to transfer balances from other credit cards or pay down loans.
If the balance transfer offer has a promotional 0% APR, your new balance won’t accrue interest during the promotional period. And if you don’t have other purchases on your statement, your entire payment should go toward the principal balance. But if you don’t pay off the balance by the end of the promotional period, the remaining balance will start accruing interest based on the card’s standard APR.
Contact your lender
If you’re having trouble with debt, you could contact your lender to see what options might be available.
But it’s important to pay attention to details to understand if short-term relief might end up costing more in the long run, depending how interest is handled.
Principal vs. interest in a nutshell
The principal balance on a loan or credit card is generally how much you borrowed. And interest can accrue on the principal based on the account’s interest rate. The more principal, the higher the interest rate and the more frequently interest accrues, the more interest you’ll have to pay overall.
Paying down a loan’s principal balance early could lead to paying less interest overall. With credit cards, you can avoid interest on purchases by paying your bill in full each month or looking for promotional interest rate offers.
For example, Capital One’s low introductory rate credit cards may offer a promotional 0% APR on purchases and balance transfers. View important rates and disclosures. You can use the cards to finance a purchase, and your entire payment could go toward the principal balance during the promotional period.