Loans & debt

Principal and interest: Definition, Formula and Example

Principal is the outstanding amount borrowed; interest is the charge for using that money over time.

Scope: General financial concept; examples are hypothetical.

Other names and related labels: Loan principal; P&I payment.

How it works

A payment may cover fees and accrued interest before reducing principal. On a standard amortizing loan, the interest portion changes as the balance changes. Mortgage escrow, insurance and taxes may increase the total payment without reducing the loan balance.

For one regular period: interest = opening principal × periodic rate; principal repaid = payment − interest

This simple split excludes fees, arrears and contract-specific allocation rules. Daily-interest contracts also depend on elapsed days.

Splitting a $1,000 payment

Start with $12,000 outstanding at 6% nominal annual interest with monthly periods.

  1. Monthly interest: $12,000 × 0.06/12 = $60.
  2. Principal repaid: $1,000 − $60 = $940.
  3. Closing principal: $12,000 − $940 = $11,060.

Of this payment, $940 reduces principal and $60 pays interest.

One regular month; no fees, escrow, new borrowing or prior unpaid interest.

The worked example uses the assumptions above. Related tools may model a different scope; check their descriptions before comparing results.

Paying $1,000 does not mean the debt falls by $1,000

Only the principal portion reduces the balance. Extra payments can change future interest if applied to principal, but prepayment terms and payment allocation should be checked in the contract.

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Sources and checks

Calculation methodology and review status · All glossary terms