Is there any circumstance in which it is necessary to mark extra payments on a loan as going to “principal and not interest”?
It could be a couple of things besides extra principal: I seem to remember hearing that some (shady?) lenders would just pocket extra payments if you didn't specify where they were headed, but I've also been told that this just isn't true. The mortgage I got last year through Wells Fargo explicitly indicates in its terms that excess payment will be considered against future payments (i.e., pay $500 extra in January and you owe $500 less in February) unless indicated otherwise. It goes on to state that with electronic payments you do not get to specify where excess payment goes, so excess payment made electronically always goes toward future payments. If you want to make excess payments toward principal, you must actually send them a check and your payment stub, with the appropriate box ticked.  This won't be very different for other major banks, I wouldn't imagine. I had a car loan through GMAC and extra money was applied to future payments.   At one point, I received a statement telling me I had 15 months until my next payment was due because I had not marked extra payments as going to principal. I would always presume that given a choice of doing what is in its own self interest verses in the customer's interest, a bank will ALWAYS do the former rather than the latter. Banks are in the business of making money, always presume that their policies, processes and contractual terms will be slanted to maximize their ability to make money.  It's not being evil or anything, it's just business, they are under no obligation to be altruistic or do what's best for you at the expense of their profits. So, especially since it's not exactly a hardship, I would always make extra principal payments using a separate check and clearly mark it as an extra principal payment.
No.    Net profit is calculated after taxes. Loan interest is an expense, so it will result in the company paying less taxes (it acts as a tax shield), so net profit should still be positive. How much will depend on tax and interest rate.    Only the portion of the $1.000.000 that correspond to interest is an expense. Principal payments are not. The reason it's broken out is very specific: this is showing you how much interest accrued during the month.  It is the only place that's shown, typically. Each month's (minimum) payment is the sum of [the interest accrued during that month] and [some principal], say M=I+P, and B is your total loan balance.  That I is fixed at the amount of interest that accrued that month - you always must pay off the accrued interest.  It changes each month as some of the principal is reduced; if you have a 3% daily interest rate, you owe (0.03*B*31) approximately (plus a bit as the interest on the interest accrues) each month (or *30 or *28).  Since B is going down constantly as principal is paid off, I is also going down. The P is most commonly calculated based on an amortization table, such that you have a fixed payment amount each month and pay the loan off after a certain period of time.  That's why P changes each month - because it's easier for people to have a constant monthly payment M, than to have a fixed P and variable I for a variable M. As such, it's important to show you the I amount, both so you can verify that the loan is being correctly charged/paid, and for your tax purposes. "So with any debt, be it a loan or a bond or anything else, you have two parts, the principal and the interest. The interest payment is calculated by applying the interest % to the principal. Most bonds are ""bullet bonds"" which means that the principle remains completely outstanding for the life of the bond and thus your interest payments are constant throughout the life of the bond (usually paid semi-annually). Typically part of the purpose of these is to be indefinitely refinanced, so you never really pay the principal back, though it is theoretically due at expiration.  What you are thinking of when you say a loan from a bank is an amortizing loan. With these you pay an increasing amount of the principal each period calculated such that your payments are all exactly the same (including the final payment).  Bonds, just like bank loans, can be bullet, partially amortizing (you pay some of the principle but still have a smaller lump sum at the end) and fully amortizing. One really common bullet structure is ""5 non-call 3,"" which means you aren't allowed to pay the principle down for the first three years even if you want to! This is to protect investors who spend time and resources investing in you!" "Depending on how you view the loan, it could either be considered an Asset or a Liability.  Since you are not charging interest, it might seem more intuitive to create an ""Assets:Cash Loan"" account, and transfer money to & from it (when you receive payments) like you would with a bank account. Personally, I prefer to think of all loans as liabilities.  Whether it's a debt which you owe someone, or a balance which someone else owes you, since it's an 'unsettled' amount I file it under ""Liabilities:Loan"".  Either way, you record the initial balance as a debit from your bank, and then record payments as credits back to your primary account. The only way that income or expenses ever gets involved would be if you charged interest (income) or if you forgave some or all of the loan (expense) at some point in the future." No offense to any bankers who are reading, but i find it remarkable that they can confuse what I'd expect to be an otherwise simple explanation. If at the end of each day the interest is added, you go to sleep with a new balance. At the moment it's added, you have no interest due, just a higher principal amount than when you went to sleep last night. When I view my loan, I know how much interest added to principal since the last payment. Any amount I pay over that has to go to principal. Forgive me, but the rest sounds like nonsense. "The other answers have touched on amortization, early payment, computation of interest, etc, which are all very important, but I think there's another way to understand the importance of knowing the P/I breakdown. The question mentions the loan payment as ""cash outflow"". That is true, but from an accounting perspective (disclaimer: I am not an accountant, but I know enough of the basics to be dangerous), the outflow needs to be directed to different accounts. The loan principal appears as a liability on your personal balance sheet, which you could use, for example, in determining net worth. The principal amount in your payment should be applied to reduce the liability account. The interest payment goes into the expense account.  Another way to look at it is that the principal, while it does reduce your cash account, can be thought of as an internal transfer to the liability account, thus reducing the size of the liability. The interest payment cannot. Aside: From this perspective, the value of the home is an asset, and the difference between the asset account and the loan liability account is the equity in the house (as pointed out in different language by the accepted answer). Of course, precisely determining the value of an illiquid asset like a house at any given moment pretty much requires you to actually sell it, so those accounts are hard to maintain in real-time (the liability of the loan is much easier to track)." "So, let's take a mortgage loan that allows prepayment without penalty. Say I have a 30 year mortgage and I have paid it for 15 years. By the 16th year almost all the interest on the 30 year loan has been paid to the bank This is incorrect thinking.  On a 30 year loan, at year 15 about 2/3's of the total interest to be paid has been paid, and the principal is about 1/3 lower than the original loan amount.  You may want to play with some amortization calculators that are freely available to see this in action.   If you were to pay off the balance, at that point, you would avoid paying the remaining 1/3 of interest.   Consider a 100K 30 year mortgage at 4.5% In month two the payment breaks down with $132 going to principal, and $374 going to interest.  If, in month one, you had an extra $132 and directed it to principal, you would save $374 in interest.  That is a great ROI and why it is wonderful to get out of debt as soon as possible.   The trouble with this is of course, is that most people can barely afford the mortgage payment when it is new so lets look at the same situation in year 15. Here, $271 would go to principal, and $235 to interest.  So you would have to come up with more money to save less interest.  It is still a great ROI, but less dramatic.   If you understand the ""magic"" of compounding interest, then you can understand loans.  It is just compounding interest in reverse.  It works against you." "The one thing that I saw in here that raised a big red flag is that you said you ""overpaid"" on your interest.  ALWAYS make sure you tell them that any extra money should be applied to principal only, not to interest.  You accrue interest based on your outstanding principal amount, so getting that lower reduces the overall amount of interest you end up paying.  Paying the interest ahead saves you nothing.  However, make sure you pay the current interest owed that month. They can capitalize past due interest - in affect, change that to be considered an addition to the loan principal amount and you end up paying interest on the interest." It used to be much more common, particularly for sub-prime loans. If you do run into someone offering a loan with a prepayment penalty, you should certainly consider other options. If there's no prepayment penalty, and if the extra is applied to principal rather than just toward later payments, then paying extra saves you money. Paying more often, by itself, doesn't. Paying early within a single month (ie, paying off the loan at the same average rate) doesn't save enough you be worth considering "Yes, your debt goes up by that amount. It becomes part of the loan, and you'll pay interest on it. That's what ""capitalization "" means. It's not a bill because you don't have to pay it. We'll, not yet…" It is often the case (more commonly in countries other than the USA) that a fixed-term loan has an early redemption penalty, because the lender themselves will incur a cost for settling the loan early, while a variable-rate loan does not. If this is the situation and you think you might want to pay off the loan early, you should definitely consider the variable rate rather than then fixed rate. There is no interest outstanding, per se.  There is only principal outstanding.  Initially, principal outstanding is simply your initial loan amount. The first two sections discuss the math needed - just some arithmetic. The interest that you owe is typically calculated on a monthly basis.  The interested owed formula is simply (p*I)/12, where p is the principal outstanding, I is your annual interest, and you're dividing by 12 to turn annual to monthly. With a monthly payment, take out interest owed.  What you have left gets applied into lowering your principal outstanding.  If your actual monthly payment is less than the interest owed, then you have negative amortization where your principal outstanding goes up instead of down. Regardless of how the monthly payment comes about (eg prepay, underpay, no payment), you just apply these two calculations above and you're set.  The sections below will discuss these cases in differing payments in detail. For a standard 30 year fixed rate loan, the monthly payment is calculated to pay-off the entire loan in 30 years.  If you pay exactly this amount every month, your loan will be paid off, including the principal, in 30 years.  The breakdown of the initial payment will be almost all interest, as you have noticed.  Of course, there is a little bit of principal in that payment or your principal outstanding would not decrease and you would never pay off the loan. If you pay any amount less than the monthly payment, you extend the duration of your loan to longer than 30 years.  How much less than the monthly payment will determine how much longer you extend your loan.  If it's a little less, you may extend your loan to 40 years.  It's possible to extend the loan to any duration you like by paying less.  Mathematically, this makes sense, but legally, the loan department will say you're in breach of your contract. Let's pay a little less and see what happens.  If you pay exactly the interest owed = (p*I)/12, you would have an infinite duration loan where your principal outstanding would always be the same as your initial principal or the initial amount of your loan.   If you pay less than the interest owed, you will actually owe more every month.  In other words, your principal outstanding will increase every month!!!  This is called negative amortization.  Of course, this includes the case where you make zero payment.  You will owe more money every month. Of course, for most loans, you cannot pay less than the required monthly payments.  If you do, you are in default of the loan terms. If you pay more than the required monthly payment, you shorten the duration of your loan.  Your principal outstanding will be less by the amount that you overpaid the required monthly payment by.  For example, if your required monthly payment is $200 and you paid $300, $100 will go into reducing your principal outstanding (in addition to the bit in the $200 used to pay down your principal outstanding).  Of course, if you hit the lottery and overpay by the entire principal outstanding amount, then you will have paid off the entire loan in one shot! When you get to non-standard contracts, a loan can be structured to have any kind of required monthly payments.  They don't have to be fixed.   For example, there are Balloon Loans where you have small monthly payments in the beginning and large monthly payments in the last year.   Is the math any different?  Not really - you still apply the one important formula, interest owed = (p*I)/12, on a monthly basis.  Then you break down the amount you paid for the month into the interest owed you just calculated and principal.  You apply that principal amount to lowering your principal outstanding for the next month. Supposing that what you have posted is accurate, the most likely scenario is that you have a structured 5 year car loan where your monthly payments are smaller than the required fixed monthly payment for a 5 year loan, so even after 2 years, you owe as much or more than you did in the beginning!  That means you have some large balloon payments towards the end of your loan.  All of this is just part of the contract and has nothing to do with your prepay. Maybe I'm incorrect in my thinking, but I have a question about   prepaying a loan. When you take out a mortgage on a home or a car   loan, it is my understanding that for the first years of payment you   are paying mostly interest. Correct. So, let's take a mortgage loan that allows prepayment without penalty.   If I have a 30 year mortgage and I have paid it for 15 years, by the   16th year almost all the interest on the 30 year loan has been paid to   the bank and I'm only paying primarily principle for the remainder of   the loan. Incorrect.  It seems counter-intuitive, but even in year 16, about 53% of your monthly payment still goes to interest!!!  It is hard to see this unless you try to do the calculations yourself in a spreadsheet. If suddenly I come into a large sum of money and decide I want to pay   off the mortgage in the 16th year, but the bank has already received   all the interest computed for 30 years, shouldn't the bank recompute   the interest for 16 years and then recalculate what's actually owed in   effect on a 16 year loan not a 30 year loan? It is my understanding   that the bank doesn't do this. What they do is just tell you the   balance owed under the 30 year agreement and that's your payoff   amount. Your last sentence is correct.  The payoff amount is simply the principal outstanding plus any interest from (p*I)/12 that you owe.  In your example of trying to payoff the rest of your 30 year loan in year 16, you will owe around 68% of your original loan amount. That seems unfair. Shouldn't the loan be recalculated as a 16 year   loan, which it actually has become? In fact, you do have the equivalent of a 15 year loan (30-15=15) at about 68% of your initial loan amount.  If you refinanced, that's exactly what you would see.  In other words, for a 30y loan at 5% for $10,000, you have monthly payments of $53.68, which is exactly the same as a 15y loan at 5% for $6,788.39 (your principal outstanding after 15 years of payments), which would also have monthly payments of $53.68. A few years ago I had a 5 year car   loan. I wanted to prepay it after 2 years and I asked this question to   the lender. I expected a reduction in the interest attached to the car   loan since it didn't go the full 5 years. They basically told me I was   crazy and the balance owed was the full amount of the 5 year car loan.   I didn't prepay it because of this. That is the wrong reason for not prepaying.  I suspect you have misunderstood the terms of the loan - look at the Variable Monthly Payments section above for a discussion.   The best thing to do with all loans is to read the terms carefully and do the calculations yourself in a spreadsheet.  If you are able to get the cashflows spelled out in the contract, then you have understood the loan. If it is a business loan, the borrower would be able to claim a deduction for any interest paid on the loan and the lender would include the interest earned as part of their taxable income. You need to be careful on what you do and don't include as income. If the repayments made to you by the borrower in a year is $10,000 but only $8,000 of that is interest and the other $2,000 is part of the principal being returned to the lender, then you would only claim $8,000 as your income and the borrower would only claim $8,000 as a business deduction. Of course if it is interest only, then you and the borrower would use the full $10,000. the government wants to tax your money before you die. If you die your 401(k) becomes part of your estate and will not be taxed to as great an extent.