Quick answer
Prepaid interest is interest paid in advance for some or all of a loan's term, rather than month by month. In business lending it's usually deducted from the loan at settlement, so the borrower receives less cash than the loan amount but has no interest repayments during the prepaid period. It's common on caveat, bridging and other short-term private loans. Always ask whether unused prepaid interest is refunded if you repay early.
Key points
- Interest for an agreed period is paid upfront, usually taken from the advance
- You owe the full loan amount but receive less in hand
- Common on caveat, bridging and private loans of a few months to a year
- Check whether unused interest is refunded on early repayment
Here’s the moment prepaid interest catches people out: the loan contract says $300k, but $268k arrives in the account. Nothing has gone wrong. The lender has kept back the interest for the term, plus its fees, and you’ll still repay $300k at the end.
How prepaid interest works
The lender calculates interest for an agreed period, often the whole term on loans of three to twelve months, and deducts it from the advance at settlement. Some lenders prepay only the first few months and then switch to monthly payments.
In return, there are no interest repayments while the prepaid period runs. For a business waiting on a property sale, a tax refund or a big contract payment, that’s the point: the loan doesn’t drain cash flow, and it’s settled in one hit when the money arrives.
Prepaid interest is also called retained interest or interest held back. On the settlement statement it usually appears as its own line, separate from the establishment fee and legal costs.
Why it matters when you borrow
Prepaid interest changes the maths in three ways:
- You need to borrow more to net what you need. If a supplier payment is $250k, the gross loan has to cover the payment plus the prepaid interest and fees.
- The headline loan overstates the cash. Compare offers on the dollars you actually receive and the dollars you repay, not the loan amount.
- Early repayment rules matter. If the property sells in month four of a nine-month loan, a refund of the unused five months could be worth thousands. Without one, you’ve paid for time you didn’t use.
It’s most common on caveat loans, bridging finance and other short private loans. Banks and longer-term lenders usually collect interest monthly instead.
Need a set amount in hand and unsure how big the loan should be? Tell us the figure you need and we’ll work it backwards.
A worked example
A Sunshine Coast builder needs $250k in hand to pay subcontractors while a completed house is sold. A private lender offers a six-month loan secured by a caveat over another property.
| Item | Amount |
|---|---|
| Gross loan | $285,000 |
| Prepaid interest for six months | $25,650 |
| Establishment fee and legal costs | $9,350 |
| Cash received at settlement | $250,000 |
| Amount repaid at the end | $285,000 |
The real cost is the $35,000 difference between cash received and amount repaid. Now suppose the house sells after three months. If the agreement refunds unused interest, about $12,800 comes back. If it doesn’t, the builder has paid six months’ interest for three months’ use. That one clause is worth asking about before anything else. All figures here are illustrative.
You can test your own numbers in the caveat loan calculator.
Related terms
Capitalised interest is the mirror image: interest added at the end instead of taken at the start. Interest-only loans charge interest monthly without reducing the balance. For a longer explanation, read our guide to prepaid interest loans.
Want the net figure worked out properly?
Short-term loans with prepaid interest can be exactly the right tool, provided the amount, the term and the refund terms all fit how the money will come back. Let us know the cash figure the business must end up with and where the payout will come from. Sixty seconds or so covers it, and your credit history stays unchecked at the enquiry stage. Nobody forwards your file down a queue of funders; one of our team studies the numbers and calls you back. Accurate figures on the property and your exit help us size the loan correctly first time.
Frequently asked questions
Why do lenders want interest prepaid?
It removes the risk of missed interest payments during a short loan and simplifies administration. For the borrower, it means no repayments while the money is out, which suits loans that will be repaid in one go from a sale, refinance or incoming payment.
Do I get prepaid interest back if I repay early?
It depends on the loan agreement. Some lenders refund unused interest, some refund it minus a minimum interest period, and some keep it all. Get the answer in writing before signing, because it can change the real cost by thousands.
Is prepaid interest the same as capitalised interest?
No. Prepaid interest is paid at the start, reducing the cash you receive. Capitalised interest is added to the balance and paid at the end. Both mean no regular interest repayments, but they affect your cash flow differently.
Is prepaid interest tax deductible?
Interest on business borrowings is generally deductible. When the deduction can be claimed for a prepayment depends on the rules for prepaid expenses, including a 12-month rule for small business entities. Your accountant can tell you how it applies to your loan.