Principal is the original amount of money borrowed or invested. On a $200,000 mortgage, the principal is $200,000. Interest is calculated on that amount. As you make payments, part goes to interest and part reduces the principal. Over time, the principal shrinks and the interest portion falls. On an investment, the principal is what you put in. Returns are earned on top of it.

The distinction between principal and interest matters. Early in a loan, most of the payment goes to interest. Late in the loan, most goes to principal. That is why extra payments early in a mortgage save so much. They reduce the balance on which future interest is calculated. On a credit card, minimum payments barely touch the principal. The balance lingers for years.

Principal also appears in investing. If you invest $10,000 and it grows to $15,000, the principal is still $10,000. The $5,000 is return. If you withdraw the return and leave the principal, you preserve the base. If you withdraw the principal, you reduce future earning capacity. Protecting principal is a common goal for conservative investors. Riskier strategies accept the chance of losing principal in exchange for higher potential returns. The term is simple. The implications are not.

Key points

• Original loan amount
• Original investment amount
• Interest is calculated on principal
• Extra payments reduce principal
• Distinct from interest and returns