Principal

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What is a 'Principal'

Principal is most commonly used to refer to the amount borrowed or the amount still owed on a loan, separate from interest. If you take out a $50,000 loan, for example, the principal is $50,000, so if you pay off $30,000, the remaining $20,000 left to repay is also called the principal.

BREAKING DOWN 'Principal'

When making monthly payments on a loan, the amount of your payment goes first to cover accrued interest charges, and the remainder is applied to your principal. Paying down the principal of a loan is the only way to reduce the amount of interest that accrues each month.

Original Investment

Principal is also used to refer to the original amount of investment, separate from any earnings accrued. Assume you deposit $5,000 into an interest-bearing savings account, for example. At the end of 10 years, your account balance has grown to $6,500. The $5,000 you initially deposited is your principal, while the remaining $1,500 is attributed to earnings.

Face Value of a Bond

The face value, or par value, of a bond is also called its principal. This is not the same as the bond's price. A bond's principal is the amount of money the bond-issuer owes to the bondholder upon maturity. Depending on the state of the bond market, a bond may be purchased for more or less than its principal.

Owner

The owner of a private company is also referred to as a principal. This is not necessarily the same as a CEO. Rather, the principal is the primary investor or the person who owns the largest share of the business. There may be one principal or several who all invest the same amount in the business.

Responsible Party

The term "principal" also refers to the party who has the power to transact on behalf of an organization or account and takes on the attendant risk. A principal can be an individual, corporation, partnership, government or nonprofit. Principals may elect to appoint agents to operate on their behalf.

A common use of this definition is found in finance. When a person hires a financial advisor, that person is considered a principal while the advisor is the agent. The agent follows instructions given by the principal and may act on his behalf within specified parameters. However, the principal retains the risk for any action or inaction on the part of the agent. If the agent makes a bad investment, it is still the principal that loses money.

It is generally assumed that an agent is required to operate in the best interest of the principal, but whether or not a given advisor is legally bound by fiduciary duty is another matter.

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