Prepaid or capitalised interest: loans with no monthly repayments

Monthly repayments make sense when a loan is repaid slowly out of income. Many short-term secured business loans aren’t like that. They’re repaid in one go, when a property sells, a contract pays out, or a bank refinance settles. For those loans, carving a repayment out of the business every month can drain the very cash flow the loan was meant to protect.

That’s why private secured loans can be set up with interest either prepaid or capitalised, so there may be no monthly repayments at all during the term. It’s arranged deal by deal, and it suits some borrowers far better than others.

How does prepaid interest work?

With prepaid interest, the interest for an agreed period, often the full term, is set aside at settlement. In practice the interest is usually deducted from the loan advance, so you don’t hand over cash; you simply receive less of the loan.

What that means for you:

• No repayments during the prepaid period. The interest has already been dealt with.
• You borrow more to net the same cash. If you need $400k in hand, the loan has to cover $400k plus the prepaid interest.
• Certainty. You know the interest cost for the prepaid period on day one.
• A cleaner exit. At the end, you repay the principal (plus any costs set out in your offer), rather than principal plus accrued interest.

How does capitalised interest work?

Capitalised interest is added to the loan balance as it accrues rather than paid. Nothing comes out of your account during the term; instead the amount owing grows, and the whole lot is repaid at the exit.

• More cash at the start. You receive the full advance (less fees and costs), with nothing held back for interest.
• The balance rises over the term. Your payout figure at the end is higher than the amount you received.
• Equity has to cover the growth. The lender needs room on the title for the balance at the end of the term, not just at the start, so it allows for that when setting the loan amount.

How interest is calculated on a capitalised balance is set out in your loan documents. Read that section closely, or have your solicitor do so.

Prepaid, capitalised or monthly: which suits which situation?

Feature	Monthly repayments	Prepaid interest	Capitalised interest
Payments during the term	Yes, each month	None for the prepaid period	None
Cash received at settlement	Full advance less costs	Advance less costs and prepaid interest	Full advance less costs
Amount owing at the exit	Principal	Principal	Principal plus capitalised interest
Who it tends to suit	Businesses with steady surplus income	Borrowers who want certainty and a fixed payout	Projects that earn nothing until a sale or refinance
What to watch	Cash flow strain in slow months	Larger loan needed for the same cash	Equity buffer shrinking as the balance grows

Illustrative example: a Perth builder needs $500,000 of working capital for 12 months, secured on two completed townhouses he owns and plans to sell. To keep this simple, assume interest for the year works out at $60,000 (a round illustrative figure, not a quote).

• Prepaid: the loan is set at about $560,000. The builder receives roughly $500,000 after the prepaid interest is set aside (fees aside), makes no payments for 12 months, then repays about $560,000 from the sales.
• Capitalised: the loan starts at $500,000 and the balance climbs over the year. At the exit it’s roughly $560,000 or a little more, depending on how interest accrues under the loan terms.

Either way, the builder’s cash stays in the project, and the sale proceeds clear the debt. The lender checks that the two townhouses have enough equity to cover the end balance with room to spare. If you’re a developer, see developer finance secured on property.

How do I know the equity covers the interest?

This is the part people underestimate. With capitalised interest in particular, the lender is lending not just today’s advance but tomorrow’s interest as well. So the usable equity has to stretch further. A property that comfortably supports $500k today may only support a slightly smaller advance once a year of interest is allowed for.

Work through the numbers on how much equity can I use and leave headroom for:

• the full term’s interest
• costs to sell or refinance at the end
• a possible delay in your exit

A short-term first mortgage of 1 to 24 months is where these options are most commonly used. Second mortgages and caveat loans are typically shorter.

What does the ATO say about prepaid interest?

Tax is your accountant’s territory, but two pieces of ATO guidance are worth knowing about before you speak with them:

1. Interest on business borrowings. The ATO lists interest on money borrowed for producing assessable income, or for buying income-producing assets, among deductible operating expenses.
2. Prepaid expenses. The ATO’s guidance on prepaid expenses explains that a small business entity (aggregated turnover under $10 million) can claim an immediate deduction for a prepayment where the eligible service period is 12 months or less and ends no later than the last day of the following income year. Businesses with aggregated turnover under $50 million can also choose to use that rule; larger businesses generally spread the deduction over the service period, capped at 10 years. Prepayments under $1,000 (excluding GST credits) are excluded from these rules.

Whether your prepaid interest fits those rules, and in which year it’s claimed, depends on the loan’s purpose, your entity and the timing. Have your accountant check before you choose a structure, particularly if settlement falls close to 30 June.

What should I check before agreeing to no monthly repayments?

• The exit date versus the term. Can your sale, refinance or payment realistically land before the term ends? The exit strategy guide helps you stress-test it.
• The Letter of Offer. It shows the loan amount, how interest is handled, the assessment fee and other costs. The private mortgage costs guide explains each line.
• Early repayment. Ask how it’s treated, and make sure the answer is in writing.

When you’re ready, tell us about the deal and your preferred structure.

Want breathing room on repayments? See if you qualify

Say what the money is for, when you expect to repay it, and whether you’d prefer prepaid or capitalised interest. Add the property details and exactly what’s owing against it, and a specialist will tell you how the structure could work and what it means for the amount you receive.

Enquiring doesn’t involve a credit check, your details aren’t handed on to a crowd of other funders, and a real person at the direct lender reads every enquiry. Prepaid, capitalised or monthly, the loan can range from $20k to $5m, there’s no formal valuation to arrange, and funding is possible within 24–48 hours of complete documents.

Ask about a loan with no monthly repayments.