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. Principal

    Most often the amount borrowed on a loan, or put into an investment, ...
  2. Reverse Mortgage Net Principal ...

    The amount of money a reverse mortgage borrower can receive from ...
  3. CMG Plan

    A mortgage plan in which a borrower's mortgage is structured ...
  4. Mortgage Accelerator

    A type of mortgage loan program popular in the United Kingdom ...
  5. Paydown Factor

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

    An increase in the principal balance of a loan caused by making ...
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. Personal Finance

    Interest-Only Mortgages: Home Free or Homeless?

    These loans can be beneficial, but for many borrowers, they present a financial trap.
  3. Taxes

    Creating a Tax-Deductible Canadian Mortgage

    Find out how to get a tax benefit from your mortgage like your neighbours to the south.
  4. Financial Advisor

    What The Series 24 Exam Won't Teach You

    Can you handle being the judge and jury in your firm? Find out what surprising tasks a job as a principal entails.
  5. Personal Finance

    What is an Amortization Schedule?

    An amortization schedule is a table that shows the amounts of principal and interest that comprise each loan payment.
  6. Investing

    Explaining Debt Service

    Debt service is a measure of a person or entity’s use of cash to pay interest and principal on debt obligations.
  7. Managing Wealth

    Agency Theory

    An agency relationship exists when one person -- called a principal -- hires another person -- the agent -- to act on his behalf. Agency theory is concerned with resolving problems that develop ...
  8. Personal Finance

    How Interest Rates Work On A Mortgage

    A step-by-step explanation of the interest calculations, mortgage types, and how the loan is eventually "retired" – which means paid off.
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. Why Do Most of My Mortgage Payments Start Out as Interest?

    When you make a mortgage payment, the amount paid is a combination of an interest charge and principal repayment. Over the ... Read Answer >>
  3. Why is more interest paid over the life of a loan when it is capitalized?

    Learn what it means to capitalize interest on a loan. Understand why more interest is paid over the life of a loan when it ... Read Answer >>
Trading Center