What is loan principal?

Principal is the capital you borrow. Interest is what the lender charges for the use of that capital, usually expressed as an annual rate. The outstanding balance on a statement may include the principal plus any unpaid interest and fees, which is why "I owe $X" usually refers to the balance rather than the principal alone.

Interest for a period is worked out on the outstanding principal, so a larger principal means more interest accrues each day or month. On a repayment schedule each payment is split into an interest portion and a principal portion. Because interest accrues on what remains, repayments that reduce principal early have a compounding benefit: lower principal, lower future interest, and more of each repayment going to principal.

With principal and interest (P&I) repayments, each payment covers the interest charged first and the rest reduces the principal. Over time the principal portion grows, and the loan is fully repaid by the end of the term.

With interest-only repayments, payments cover only the interest and the principal stays the same for the interest-only period. You do not build equity through repayments, and when the period ends repayments must rise to start reducing principal, or a lump sum may be required. Principal-only payments are less common on consumer mortgages: where a lender accepts them they reduce principal directly and cut future interest immediately, so check for restrictions or fees.

Paying principal down sooner reduces the interest you pay over the life of the loan. Regular extra repayments, even small weekly amounts, add up. Switching to fortnightly repayments of half the monthly amount produces the equivalent of thirteen monthly payments a year. Lump sums from bonuses or savings work the same way.

An offset account reduces the balance interest is calculated on, because interest is charged on the net figure. A redraw facility lets you take back extra repayments, which is handy for flexibility, but any redraw increases the principal on which interest is charged. Splitting the loan or using a line of credit can add flexibility; more complex structures are worth discussing with a professional adviser. MoneySmart's mortgage calculator shows the exact effect of extra repayments on your term and total interest.

Opening and closing balances show the principal outstanding at the start and end of the statement period, although some lenders include accrued interest in these lines. Principal repaid (or principal portion) is the part of your payments that reduced the principal during the period, and interest charged or accrued is the interest applied, which may appear separately from payments.

Available redraw shows how much extra principal you have repaid and can withdraw, if the loan allows it, and offset balance shows linked offset funds that reduce the interest calculation. Some lenders present an outstanding balance that already nets off pending interest; others show principal and accrued interest separately. If in doubt, check lines such as principal repaid year to date or principal outstanding, and ask your lender for a plain-language explanation.