There exist several financial areas that engage in a lot of transactions with various parties and people in general. The world of commerce has immensely developed, and many changes have been made to the processes that take place.
There are several transactions and other processes that take place between several organizations, parties, people and banks as well.
Whenever a person borrows money from a certain institution, there are some procedures or methods levied when the person has to return the borrowed money.
Two such terminologies or methods that are used are 1. Principal, and 2. Interest.
Key Takeaways
- The principal is the initial amount of money borrowed or invested.
- Interest is the amount paid for using borrowed money or earned on invested money.
- The interest amount is calculated as a percentage of the principal amount.
Principal vs Interest
The difference between principal and interest is their meaning or definition. The total amount of money that is borrowed from a person or that is invested by a person on which a certain amount of interest is levied is known as the principal, on the other hand, the amount of money that is supposed to be paid along with the repayment of the principal is known as interest.
The amount of money that is lent to a borrower is known as the principal. In the financial world, the term “principal” has several meanings depending on the context.
For instance, the principal is the initial amount of loan that a borrower must repay, on the other hand, the main parties that are involved during various transactions are also known as principals in the context of contracts and ventures.
The amount of money that is supposed to be paid along with the repayment of the principal is known as interest. It is a type of monetary charge. The history of compound interest dates back to 2400 BC.
It was considered one of the necessary steps for growth in areas like agriculture and urbanisation. However, charging interest during medieval times was considered morally invalid.
Comparison Table
| Parameters Of Comparison | Principal | Interest |
|---|---|---|
| Meaning/ Definition | The amount of money that is lent to a borrower is known as the principal. | The amount of money that is supposed to be paid along with the repayment of the principal is known as interest. |
| Formula | P= I/ RT | Simple interest = P•R•T/ 100 |
| Subtypes | Bonds, investments, loans, companies, transactions | Fixed interest, variable interest, annual percentage rate, prime rate, discount rate, simple interest, compound interest. |
| Type of | Borrowed amount | Extra amount or a monetary charge |
| Related terms | Bonds, face value, market value, investments, loans, private companies etc. | Simple interest, compound interest, interest rate, prime rate etc. |
What is Principal?
The amount of money that is lent to a borrower is known as the principal. The principal is the amount that is borrowed by the borrower from a certain financial institution or any other resource.
In the financial as well as the business world, the term “principal” has various interpretations depending on its usage.
For instance, the principal is the initial amount of loan that a borrower must repay, on the other hand, the main parties that are involved during various transactions are also known as principals in the context of contracts and ventures.
Other than that, the majority of stakeholders in a company in business is also referred to as principal.
The original amount of money committed by an investor at the time of purchase of assets is also called principal. The resolution of the amount of interest that is supposed to be paid by the borrower is based on the amount of the principal.
The interest rate that is supposed to be levied is also determined based on the amount of principal.
All in all, one can interpret that the amount of money borrowed is known as a loan, the money invested by an investor during an investment, the face value possessed by a bond, and other transactions and companies are also considered types of principal.
What is Interest?
The amount of money that is supposed to be paid along with the repayment of the principal is known as interest. It is a type of monetary charge. The history of compound interest dates back to 2400 BC.
It was considered one of the necessary steps for growth in areas like agriculture and urbanisation.
During the Renaissance era, there was an increase in commerce, and many entrepreneurs initiated lucrative business ideas. This gave rise to the usage of interest during the transactions that were carried out.
However, charging interest during medieval times was considered morally invalid.
Several types of interest include fixed interest, variable interest, annual percentage rate, prime rate, discount rate, simple interest, and compound interest.
These types have their independent meaning and usage in the financial as well as in the business world. The interest rate depends on the principal amount, and it is determined based on the amount of principal the borrower borrows.
The fixed interest is a fixed amount of money that is supposed to be paid during the repayment of the principal by the borrower. Variable interest, on the other hand, is completely different from fixed interest.
The amount of interest in the variable interest fluctuates depending on the ongoing movement of base interest rates.
The annual percentage rate interest is the interest that is levied annually along with the principal. The economic world has a different meaning of interest. It is considered the price of credit, and it also plays the role of cost of capital.
Different places have different inter of the term “interest”.
Main Differences Between Principal and Interest
- The total amount of money that is borrowed from a person or that is invested by a person on which a certain amount of interest is levied is known as the principal, on the other hand, the amount of money that is supposed to be paid along with the repayment of the principal is known as interest.
- The principal is an independent entity, on the other hand, interest is an entity that is dependent on the principal. If the principal is not borrowed, then the interest won’t exist.
- The principal is a borrowed amount, on the other hand, the interest is an extra amount of a type of monetary charge.
- The types of principals include bonds, investments, loans, companies, transactions etc, on the other hand, the types of interest include fixed interest, variable interest, annual percentage rate, prime rate, discount rate, simple interest, compound interest etc.
- The formula that is used to calculate principal is P= I/ RT, on the other hand, is a formula that is used to calculate simple interest is, Simple interest = P•R•T/ 100.
- https://search.proquest.com/openview/a081b45b7e66e89391308164f90c4a6f/1?pq-origsite=gscholar&cbl=3330
- https://heinonline.org/hol-cgi-bin/get_pdf.cgi?handle=hein.journals/duklr1981§ion=41
Last Updated : 23 July, 2023
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.
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