DEFINITION of 'Principal Reduction'

A decrease in the principal owing on a loan, typically a mortgage, for the purpose of lessening the outstanding principal balance on qualifying properties that have negative equity. Principal reduction is normally employed to prevent foreclosures on properties, which may be more costly to financial institutions than a reduced principal owed to them. As a result, principal reduction typically requires specific requirements in order for a homeowner to qualify, such as ability to commit to payments, to whom a mortgage payer owes the principal and whether the total balance owing on the mortgage is greater than the value of the property.

BREAKING DOWN 'Principal Reduction'

Typically, principal reduction programs are government-mandated, offered by firms such as Fannie Mae and Freddie Mac in order to relieve homeowners of a degree of debt-burden. Principal reduction is in essence debt relief, which counts as income on a tax return and thus is subject to tax. However, those who qualified for the Mortgage Forgiveness Debt Relief Act of 2007 were able to exclude some canceled debt on their primary residence while filling out their tax forms.

RELATED TERMS
  1. Paydown Factor

    The portion of cash subtracted each month from the principal ...
  2. Negative Amortization

    An increase in the principal balance of a loan caused by making ...
  3. Power of Attorney of Property

    A legal document transferring the legal right to the attorney ...
  4. Dual Currency Issue

    A bond that pays interest in one currency but pays the principal ...
  5. Interest Due

    The portion of a current mortgage payment that is comprised of ...
  6. Deferred Interest Mortgage

    A mortgage loan that allows the borrower to make minimum payments ...
Related Articles
  1. Personal Finance

    Understanding the Mortgage Payment Structure

    We explain the calculation and payment process as well as the amortization schedule of home loans.
  2. Investing

    Understanding The Mortgage Payment Structure

    While a mortgage’s size and term set the baseline, the interest, taxes and insurance all influence the amount of the monthly payment.
  3. Investing

    How To Afford A Second Home

    Buying a second home, even if it’s relatively affordable, takes careful budgeting and planning. Here's how to do it.
  4. Investing

    Canada: A New Frontier For Real Estate Investors

    This property market is easy to access and provides profitable opportunities.
  5. Personal Finance

    Score a Cheap Mortgage, Here’s How

    Hidden costs can create what looks like a good deal. Find out how to find the best mortgage possible.
  6. Personal Finance

    How Mortgage Refinancing Affects Your Net Worth

    Find out how to determine whether refinancing will put you ahead or even more behind.
  7. Personal Finance

    Reduce Interest With An All-In-One Mortgage

    "Offset" mortgages combine a checking account, home-equity loan and mortgage into one account.
  8. Personal Finance

    Mortgages: Fixed-Rate Versus Adjustable-Rate

    Both of these have advantages and disadvantages depending on your financial needs and prospects.
  9. Personal Finance

    Mortgage Options for Underwater Homeowners

    Find out what options are available when your mortgage is greater than the value of your home.
RELATED FAQS
  1. What are the responsibilities of the principal in a company?

    Learn to differentiate between some of the many definitions and responsibilities of a "principal" as it relates to business ... Read Answer >>
  2. How does the amount of the principal fluctuate depending on inflation?

    Read about the impact of inflation on your principal balances, and learn why inflation harms lenders and bondholders at the ... Read Answer >>
Trading Center