What is Principal?

Principal is the original sum of money borrowed in a loan agreement, or the outstanding unpaid balance of that loan, distinct from interest, fees, or taxes. During the life of a standard amortized mortgage, each monthly payment is divided between paying down the outstanding principal balance and covering the interest charges accrued since the last payment. Because interest is calculated directly as a percentage of the remaining unpaid principal balance, the distribution of the payment shifts over time. In the initial years, the majority of the monthly payment is consumed by interest, but as the principal balance slowly declines, the monthly interest charge decreases, allowing a larger portion of subsequent payments to be applied toward the principal.

Borrowers can accelerate equity accumulation and reduce the total cost of borrowing by making extra, 'principal-only' payments. Because these funds directly lower the outstanding balance, they decrease the base on which future interest is calculated, potentially shaving years off the loan term and saving tens of thousands of dollars in compounding interest. However, borrowers must explicitly instruct their mortgage servicer to apply these extra payments to the principal balance rather than prepaying the next month's scheduled installment.

For tax purposes in the United States, under the Tax Cuts and Jobs Act (TCJA), mortgage interest may be tax-deductible on up to $750,000 of qualifying home acquisition debt (or $375,000 if married filing separately). In contrast, principal payments do not qualify for any tax deductions and serve solely to build home equity. Mortgage servicers report the annual breakdown of interest paid and the remaining principal balance on IRS Form 1098, which is used to substantiate these deductions.