Commonly, ‘principal’ refers to the initial sum of money either borrowed as a loan or debt or used as a form of investment. However, in finance, the term has several meanings, including the face value of a bond. On the other hand, this is also used to refer to a single party or parties, the owner of a privately-owned company, or the main participant in a financial transaction.
What is a mortgage principal?
This refers to the size of a home loan that is backed by a collateral. Depending on the terms, a mortgage agreement will outline calculations of present interest rate and terms for principal repayment.
For example, a borrower takes out a $50,000 mortgage. This means the principal is the same amount borrowed initially. If the borrower repays $30,000 off the original loan amount, the outstanding principal is $20,000.
Therefore, the total interest a borrower must pay depends on the principal sum. Take for instance a borrower whose principal amount is $10,000. If the loan comes with an annual interest rate of 5 percent, the borrower must pay at least $500 in interest every year.
When monthly payments on a loan are made, the paid amount is used to cover the accrued interest charges first before applying the remainder on the principal. By paying the principal down, the borrower can reduce the amount of interest accrued monthly.
Zero Principal Mortgage
Otherwise known as interest-only mortgage, this is a form of real estate financing wherein the borrower makes regular payments to cover the interests on a loan. This is different from paying both the principal and interest.
Consequently, this means that the borrower does not make progress in reducing the principal balance of the loan or paying off the total debt amount, or build equity in the property that is mortgaged.
For this very reason, zero principal mortgages are not an ideal option. However, there may be instances when this is useful for people who are just starting their career with low income.