What is Principal Amount in Personal Loans, and Why Is It Important?

What is the Principal Amount in a Personal Loan?

The principal amount is what you’ve borrowed. Yes, the loan amount is considered as the principal amount when computing your loan repayment. If you are familiar with the EMI calculation formula:

EMI = [P × R × (1 + R)^N] / [(1 + R)^N − 1]

In this formula, P stands for the principal amount, which is the loan you’ve taken out from the bank or NBFC.

Suppose you’ve borrowed a loan of ₹5,00,000, and the EMI is ₹11,634 for an interest rate of 14.00% per annum. The tenure for this loan is 5 years, so according to the EMI formula, your total interest payable is ₹1,98,048.

How Does the Principal Amount Affect Loan Repayments?

On EMIs: Your EMIs are fixed in a personal loan repayment, and the same is determined based on your loan details. This includes your principal amount and interest rate. These two have a big impact on your EMIs.
Large principal amounts can result in out-of-budget EMIs, and to handle the same, you have to choose a longer term. A longer-term loan will result in high interest payments. So to avoid the same, borrow wisely when your loan request is approved.

Early Loan Closure: When you decide to close your loan before the end of the term, you should compute the outstanding principal amount. Because this is what will decide your foreclosure fee and the total amount you have to pay.
Banks charge a foreclosure fee when you close your loan. The fee is determined by your outstanding balance. For example, if your principal outstanding is Rs. 2,00,000, the foreclosure charge will be 3-4% of that amount, Rs. 6,000-8,000.

Budget Planning: Knowing your principal amount beforehand can help you plan your budget. How are you going to fit this into your monthly income? First, assess your total income, including salary, bonuses, and any additional sources of revenue. Next, outline your fixed expenses, such as rent, utilities, and loan payments, as well as your variable expenses, like groceries, entertainment, and transportation.
Once you have a clear picture of your income and expenses, determine how much you can allocate towards your principal amount. Consider creating a budget that tracks your spending and allows for adjustments if necessary. This might involve cutting back on non-essential expenses or finding ways to increase your income.

Importance of Knowing the Principal Amount

Understanding the principal amount of a personal loan is crucial for several reasons:

Improved Financial Planning: Knowing the principal amount helps borrowers assess their financial situation more accurately. It allows them to budget effectively and allocate resources toward repayment, ensuring they can manage their finances better over time.

Transparency in Loan Repayment: Being aware of the principal amount fosters transparency between lenders and borrowers. It clarifies how much of the total loan balance is the original debt, making it easier to track repayments and understand accrual of interest.

Insight into Foreclosure Savings: Knowledge of the principal amount is key when considering options for prepayment or foreclosure. Borrowers can determine the potential savings on interest if they pay off their loan early, enabling them to make informed decisions that could save them significant amounts of money in the long run.