Unpaid principal balance is that portion of a loan that has not yet been paid back to the lender by the borrower. This balance represents the remaining risk of nonpayment being incurred by the lender. 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
Thus, 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.
The situation is different for a loan structured to have a single payoff at the termination date of the loan, which is called a balloon payment. In this case, all payments made to the lender prior to the termination date are solely for interest. Thus, the unpaid principal balance remains the same for the duration of the loan.
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. They assume 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.