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Paying Down Debt: Principal vs. Interest, What’s the Difference?

August 30, 2022 • Adulting

When you apply for a loan or any type of credit, you’re asking to borrow money from your credit union or other financial institution with the understanding that you agree to pay back that debt with interest.  

The principal is the original amount you borrowed. Normally, the lender specifies in the contract that they’ll charge a certain amount in exchange for providing you access to those funds — this is called the interest.

Here are a few terms and definitions to help explain what that means:

Interest – Interest is the cost of using somebody else’s money. Lenders may charge a range of interest rates based on your credit score. 

Annual Percentage Rate (APR) – APR, is your interest rate for the entire year. For example, if your loan has an APR of 10%, you pay $10 for every $100 you borrow annually.

Interest payment – The interest payment is the amount of money that goes toward paying interest charges each month.

Principal payment – Payment made on a loan that reduces the total amount due, rather than the accumulated interest. 

Principal balance – The total unpaid balance of the amount borrowed, excluding interest.

Paying Down Principal

When you make monthly payments, everything you pay above the interest payment goes toward paying down the principal. The more you pay, the faster you reduce the principal balance, and the less interest you’ll wind up paying over the long term. Use a loan principal and interest calculator to learn how much interest you’ll pay over the term of the loan if you don’t pay down the principal. Adding a few extra dollars each time you make a payment can end up saving you a lot of money over time.

The More You Know, the More You’ll Save

Understanding the effects of making principal and interest payments is a great step toward taking control of your financial life and positioning yourself for future stability and success. At Canopy, you’ll find all the resources and information you need to manage your credit and make the most of your monthly payments. We’re easy to work with and we don’t charge the fees you’ll find at a lot of other institutions. If you’re thinking about taking out a loan or opening a new credit account, talk with us. We think you’ll be glad you did.

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