Many businesses have learned that a small business loan can go a long way in helping their operation grow and succeed. A loan can provide the necessary funds to purchase or upgrade equipment, improve cash flow, hire new employees and much more.

However, before accepting a loan, it is wise to understand what the term “loan principal” means and how it can impact your loan balance. Here are a few facts to help you get started.

Loan Principal Defined

The loan principal is often described as the initial sum of money in dollars that you borrow for your business. For instance, if you take out a business loan for $30,000 to purchase new computers for your business, the loan principal dollar amount is $30,000. 

How Loan Principal and Loan Interest Differs

Business loans also usually include interest. Interest is the fee business loan lenders charge their customers to borrow money. Interest rates are typically based on criteria such as the amount of money borrowed, the lender’s loan guidelines and the borrower’s credit history. Strong credit histories and high credit scores frequently result in lower interest rates.

How Business Loan Principal Works

Here is an example of how loan principal works. Let’s say your initial loan principal is $30,000 with a 10 percent annual interest rate.

After receiving your loan proceeds, you will begin making payments on $30,000. If your monthly payment is $700, you will also need to pay an interest fee of $250 ($30,000 x (10%/12).

When you make your $700 payment, $250 of the payment covers the 10% interest, and the other $450 pays down the loan principal you owe. The result? Your loan balance will reduce to $29,550.

Although your interest rate will remain 10% through the life of the loan, with each payment, your loan principal and your loan balance will decrease until your loan is eventually paid-in-full.

Locating Your Loan Principal Details

Once you receive a business loan and begin making payments, you will receive a monthly statement. This report will show the amount you still owe for your loan principal balance, interest and other pertinent details.

Make Extra Payments to Save Money and Move Forward

Many business loans permit borrowers to make extra principal payments. By making extra principal payments, business owners can pay off the loan principal faster, which means they will pay less interest and ultimately shorten the loan’s lifespan.

What to Know About Loan Principals and Taxes

Although businesses can deduct a business loan’s interest to save money on their business taxes, they cannot deduct the loan principal. That is because the loan principal amount is repaid and not considered earned income.

Talk to Financial Experts

Obtaining a business loan is possibly one of the best moves you can make for your business if you fully understand how they work. Contact Hemingway Financial Group today to find out how the right business loan can help your business thrive.