Prepaid interest

Prepaid interest settles the interest question on day one. Instead of paying interest each month, or letting it build on the balance, the interest for an agreed period is worked out at the start and taken care of at settlement. For the rest of that period, there’s nothing to pay.

How does prepaid interest work on a secured business loan?

1. Agree the prepaid period. Often the full term, sometimes the first part of it.
2. Size the loan. The lender works out the interest for that period and adds it to the cash you need, so the loan amount covers both.
3. Settle. The prepaid interest is deducted from the advance, alongside fees and costs. You receive the net amount.
4. Run the term. No interest payments for the prepaid period.
5. Exit. You repay the principal plus any costs in the agreement. Because the interest was dealt with up front, the payout figure doesn’t grow during the prepaid period.

How does it compare with the alternatives?

Feature	Prepaid interest	Capitalised interest	Paid monthly
Interest payments during the term	None for the prepaid period	None	Every month
Cash received at settlement	Advance less costs and prepaid interest	Advance less costs	Advance less costs
Payout at the exit	Principal and costs	Principal, capitalised interest and costs	Principal and costs
Certainty of interest cost	High, fixed at settlement	Depends on how long the loan runs	Depends on how long the loan runs
Early repayment	Check the contract on unused interest	Interest stops building	Interest stops

Both prepaid and capitalised interest remove monthly payments. The prepaid or capitalised interest page explains when each tends to suit.

Why does prepaid interest matter to a borrower?

Certainty. You know the interest cost for the prepaid period before you sign, which makes budgeting the exit straightforward. The payout won’t creep up while you wait for a sale or a refinance.

No payments to miss. There’s no monthly debit for a slow trading month to upset, which removes one common path into default interest.

It suits a known finish line. Prepaid interest works best when the exit date is reasonably firm, such as a contract payment, a settlement already booked or a refinance with a clear timetable. If the timing is genuinely uncertain, capitalising the interest may fit better, because you only carry interest for the time the money is actually out.

The catch is size. Because the interest comes out of the advance, the loan has to be bigger than the cash you need, and the lender needs equity to cover the larger amount. The early repayment question matters too: if your exit could arrive early, find out in advance whether unused prepaid interest is credited back.

What does the ATO say about prepaid expenses?

The ATO defines a prepaid expense as expenditure incurred under an agreement for something to be done, in whole or part, in a later income year. For small business entities, the ATO’s 12-month rule allows an immediate deduction for a qualifying prepayment where the eligible service period is 12 months or less and ends by the last day of the following income year; otherwise the deduction is spread over the period. Separately, the ATO lists interest on money borrowed for producing assessable income among deductible operating expenses.

How these apply to your loan depends on your structure and the purpose of the borrowing, so speak to your accountant before settlement. Our guide on whether business loan interest is tax deductible covers the basics.

Illustrative example: a Wollongong electrical contractor needs $300k in hand for 12 months to fund equipment for a large commercial contract, secured on an investment property. Interest for the year is prepaid; assume, for illustration only, that it comes to $36k. The loan is set at about $336k plus costs, the contractor receives roughly $300k at settlement, makes no interest payments, and repays about $336k plus costs when the contract’s final claim is paid.

Which related terms should I know?

• Letter of offer: where the prepaid period and any early repayment terms are written down.
• Total cost of a short-term loan: adding up every cost, not just interest.

The rest are in the glossary. When you’re ready, ask whether prepaid interest suits your deal.

Would a loan with no interest payments help?

Tell us how much you need in hand, the property you’d offer, what’s owing on it and when your repayment will arrive. There’s no credit check to enquire, your details go to one direct lender rather than a broadcast list, and a real specialist reviews each enquiry. Accurate answers mean the prepaid period and loan size are set right first time. Find out if you qualify.