Unpaid Principal Balance Definition - AccountingTools

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What is an Unpaid Principal Balance?

An unpaid principal balance is that portion of a loan that has not yet been paid back to the lender by the borrower. As the borrower makes payments over time, the principal balance gradually decreases until the loan is fully paid off. For the lender, the unpaid principal balance reflects the remaining exposure to the risk that the borrower might default. Monitoring the principal balance is important for both parties to track progress and manage financial obligations effectively.

How to Calculate Unpaid Principal Balance

A typical loan payment is comprised of both an interest charge and the return of some principal, so the unpaid principal balance cannot be calculated simply by subtracting all loan payments to date from the original amount of the loan. Instead, you must also add back the amount of interest paid to the lender to arrive at the unpaid principal balance. Thus, the calculation is:

Original loan amount - Total of loan payments to date + Total interest paid to date

The interest charge contained within the next period's loan payment is derived from the unpaid principal balance at the end of the preceding period.

A common misperception with the unpaid principal balance concept is when it comes time for a homeowner to pay off a mortgage. The borrower assumes that the amount to be paid is the unpaid balance appearing on their last mortgage statement. However, the actual amount owed is this unpaid principal amount plus the amount of interest that has accrued since the date of that statement, so the interest to be paid is somewhat higher than the homeowner had expected to pay.

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Example of Unpaid Principal Balance

If ABC Company takes out a $1 million loan, has made $300,000 in loan payments since then, and the interest component of those payments was $200,000, then the unpaid principal balance is $900,000. Conversely, if the loan had been set up as having a balloon payment at the end of the loan period, then ABC would only have been paying interest over the course of the loan; in this situation, the unpaid principal balance remains at $1 million through the life of the loan.

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How is the unpaid principal balance affected by a balloon loan?

In a balloon loan, the unpaid principal balance declines slowly or not at all during the term because periodic payments are structured to cover primarily interest, or only a portion of principal. As a result, a large unpaid principal balance remains outstanding at maturity. That remaining balance becomes due in a single balloon payment, significantly affecting liquidity and refinancing risk at the end of the loan term.

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