Home Loan Principal Amount: Tips for Borrowers

There are multiple facets of a home loan. But the majority of it is covered by the part known as the home loan principal amount. Many first-time home buyers who are looking for financial assistance are often confused about these elements of a home loan. However, it will be prudent for them to get acquainted with these basic terms. The home loan principal amount is essential for various derivations within the loan. Moreover, understanding some common home loan mistakes can help a borrower make the most out of the financial service. This blog will dive deep into the home loan principal amount and its impact on a loan.

What is the Home Loan Principal Amount?

Technically, loans are composed of two elements. First, the major portion of a loan comprises the principal amount, and the interest, processing fees, and other charges cover the rest. A principal loan amount is simply the amount a borrower receives from a bank. Moreover, the interest is the amount that the lender charges the borrower for offering their financial services. The interest is calculated based on rates that adhere to the central bank standards and based on the creditworthiness of the loan customer. When it comes to a home loan, the underlying concept remains the same. The Home Loan Principal Amount refers to the original sum of money a borrower borrows from a lender to purchase a home or a property. This amount does not include any interest or fees charged by the lender.

Example

Here is an example to understand the concept of home loan principal amount concept in detail. Suppose someone takes out a home loan for INR 30,00,000, then the principal amount is INR 30,00,000. Throughout the loan duration, the borrower will make regular payments that include the principal amount and interest charges until the full loan amount is paid off. The interest will depend on the rate decided by the bank. For example, if the interest rate is 10% per annum, the yearly interest will be 10% of the principal, i.e. INR 30,00,000. Calculating the amount of interest, we will get INR 3,00,000.

Role of Principal in a Home Loan

The role of a principal in a home loan is majorly to represent the initial amount borrowed by the borrower. The principal amount is the amount that the borrower is required to repay to the lender over the life of the loan. Moreover, the loan principal amount is a crucial component of the home loan, as it determines the total interest the borrower will pay over the life of the loan. Some of the highlights of the role of the home loan principal include the following statements.

• Show the initial amount of borrowing.
• Determines the interest that the borrower will have to pay additionally.
• The higher the principal loan amount, the higher the interest charges.
• The principal loan amount is instrumental in the computation of EMIs.
• The larger the principal amount, the higher the monthly payments will be. Conversely, a lower principal amount will result in lower monthly payments.
• The loan principal amount also plays a role in the borrower’s equity in the property. As the borrower makes payments on the loan, the principal amount decreases, and the borrower’s equity in the property increases.

Factors that Determine the Principal Amount

The principal loan amount of a home loan is the amount borrowed from a lender to purchase a property. Several factors can determine the principal amount of a home loan, including:

• Property Value: The higher the property value, the higher the loan amount needed.
• Down Payment: The amount of money you are willing to put down as a down payment can also affect the principal amount of your home loan. A larger down payment means you will need to borrow less, resulting in a lower principal amount.
• Loan Term: The loan term, or the length of time you have to repay the loan, can also impact the principal amount. A longer loan term may result in a higher principal amount, while a shorter one may result in a lower principal amount.
• Credit Score: Your credit score is an important factor that lenders consider when determining the principal amount of a home loan. A higher credit score can help you qualify for a larger loan, resulting in a higher principal amount.
• Income: Your income is another factor that can impact the principal amount of your home loan. Lenders typically use your income to determine your ability to repay the loan, which can impact how much they are willing to lend you.

Importance of Paying Down the Principal

Paying down the principal on a home loan is important for several reasons:

Reduce Interest Expenses

By paying down the principal, the interest amount you owe on the remaining balance of your loan will decrease. This means that over time, you will save money on interest expenses.

Build Equity

The more principal you pay down, the more equity you will have in your home. Building equity is important because it gives you more financial options in the future, such as the ability to borrow against your home’s value or sell it for a profit.

Shorten Loan Term

When you pay down the principal, you also shorten the overall term of your loan. This means you’ll pay off your mortgage faster and potentially save thousands of dollars in interest over the life of the loan.

Improve Credit Score

Making regular payments towards the principal of your home loan can improve your credit score over time. By reducing the debt amount, you’re showing lenders that you’re responsible for your finances and can be trusted to make on-time payments.

Impact of a Larger or Smaller Principal Amount on Your Loan

The principal amount of a loan is the amount of money borrowed initially, and it can significantly impact the loan in several ways.

Larger Principal Amount

A larger principal amount will typically result in larger loan payments, as the interest charged on loan is typically calculated as a percentage of the principal. Consequently, a larger principal amount means more interest charges. Additionally, a larger principal amount may make it more difficult to qualify for the loan. Lenders will generally look at a borrower’s debt-to-income ratio when deciding whether to approve a loan, and a larger principal amount will increase the borrower’s overall debt.

Smaller Principal Amount

A smaller home loan principal amount will result in smaller loan payments and may make it easier to qualify for the loan. However, a smaller loan may also mean that the borrower is unable to purchase the desired asset or make the desired investment, as the funds available may not be sufficient.

Common Mistakes to Avoid When Managing Your Home Loan Principal

Managing your home loan principal can be a daunting task, especially if you’re a first-time homeowner. However, with the right approach and some basic knowledge, you can avoid common mistakes and save money in the long run. Here are some mistakes to avoid when managing your home loan principal:

• Not making extra payments: Paying only the minimum amount due on your home loan every month will cost you more in the long run. The interest on your loan adds up, and you end up paying a lot more than you borrowed. Making timely extra payments can help reduce the principal amount faster and save on interest.
• Not refinancing when interest rates drop: Refinancing means taking out a new loan to pay off your existing loan, usually at a lower interest rate. This can help you save money on interest charges and reduce your monthly payments.
• Not reviewing your home loan regularly: Check your statements regularly and ensure your payments are credited correctly.
• Not considering all the costs of owning a home: Owning a home comes with many additional costs, such as property taxes, insurance, maintenance, and repairs. Failing to budget for these costs can strain your finances, and you may struggle to make your loan payments.
• Not seeking advice from a financial professional: Managing your home loan can be overwhelming, and it’s essential to seek advice from a financial professional if you’re unsure about anything. A financial professional can help you make informed decisions.

By avoiding these common mistakes, you can effectively manage your home loan principal and save money in the long run.