What It Is:

In finance,  principal refers to the face amount of a debt instrument or an amount of money borrowed.

How It Works/Example:

For example, if you borrow $25,000 from XYZ Bank to purchase a car, the principal balance is $25,000. As time goes by and you make payments on the loan, the principal balance goes down.

For bonds, principal generally refers to the bond's face value or the par value. Thus, a bond with a $10,000 face value represents a $10,000 loan to the issuer (i.e., $10,000 of principal). It is usually equal to the amount the bondholder receives on the bond's maturity date.

Why It Matters:

Interest on any loan, bond or not, typically accrues on the outstanding principal balance. That is, the lower the principal outstanding, the less total interest the lender earns.