Principal

Plain-English definition. Principal is the amount of money originally borrowed under a loan, separate from the interest charged on it. As you make repayments on a P&I loan, the principal balance shrinks each month.

How it works in Australia. On a standard amortising home loan, each monthly repayment is allocated first to accrued interest and then to principal reduction. The bank calculates interest daily on the closing principal balance and charges it monthly. Extra repayments go directly against principal, immediately reducing the base on which future interest accrues. On an interest-only loan the principal does not move during the IO period. ATO interest deductibility for investors depends on the loan being used to acquire income-producing assets — principal repayments are never deductible.

Concrete example. Borrow $500,000 at 6.0% over 30 years, monthly P&I repayment $2,998. Month 1: interest $2,500 + principal $498. Month 12: interest $2,471 + principal $527. Year 5 closing principal: $466,000 (you've reduced principal by only $34,000 despite paying $179,800 in repayments — $145,800 was interest). Year 30: $0. Adding $200/month in extra repayments from day one cuts the loan term to 26 years and saves about $77,000 of interest.

Common confusion. Borrowers see early statements showing principal reductions of just a few hundred dollars and think the loan is barely moving. That's correct — the math of amortisation front-loads interest. Extra principal payments in the first 5 years do disproportionate work; the same payments in year 25 save almost nothing.