When taking out a business loan, you as the business owner need to get an understanding of the repayment schedule. Part of this is understanding principal payments and the amount owed. This is why we've compiled this short guide to calculating the principal payment.
Principal payment - explained
Principal payment refers to a payment going towards the repayment of the original amount of money borrowed through a loan. The second type of payment is interest, which is the fee charged for borrowing the funds (usually an annual percentage of the amount of the loan). A principal payment reduces the outstanding amount of a loan you need to pay back, however, not the amount of interest charged on the loan.
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How do principal payments work?
When repaying a loan through principal payments, you as the debtor have two options. You can either choose to go down the route of even principal payments, meaning the payments will be the same in every period, or even total payments, meaning the total payment amount stays the same in every period, but the principal will differ (typically increase over time, with the interest decreasing). Often, you can end up paying less with even principal payments, as interest does not increase over time.
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How to calculate monthly principal payments
It is crucial to understand how to calculate your business's principal payment. Loan repayments can be scary if you as the business owner do not keep an eye on the interest payment. The formula for calculating the monthly principal payment for your business is as follows: a / {[(1+r)^n]-1]} / [r(1+r)^n] = p.
In this, "a" stands for the total loan amount, "r" for the periodic interest rate, "n" for the total number of payment periods, and "p" for the monthly payment. However, you could also use a principal payment calculator to identify monthly payments.
These calculators can be used easily, as long as you have certain information, such as the loan amount, interest rates, payment frequency, etc.
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