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Private loans are usually interest only, and there are three ways that interest can be paid. The option chosen changes the cash you receive at settlement and the amount you repay at the end.
The three methods
| Serviced | Prepaid | Capitalised | |
|---|---|---|---|
| When interest is paid | Monthly, from your cash flow | Up front, deducted from the advance | At the end, added to the balance |
| Monthly payments | Yes | No | No |
| Cash received at settlement | Highest | Lowest | Highest |
| Amount repaid at the end | The loan amount | The loan amount | Loan plus accumulated interest |
| Compounding | No | No | Yes |
| Risk of payment default during the term | Yes | No | No |
A worked example
A company borrows $500,000 for six months at 1% a month with a 2% establishment fee.
- Serviced. Receives $490,000 after the fee. Pays $5,000 a month. Repays $500,000.
- Prepaid. Receives $460,000 after the fee and $30,000 of interest. No monthly payments. Repays $500,000.
- Capitalised. Receives $490,000. No monthly payments. Repays about $530,760.
If the company needs $490,000 in hand and cannot service monthly, the prepaid route means borrowing a larger headline amount, about $532,600, so that the net figure still works. Always ask for the net advance in writing.
The LVR effect
Lenders measure the loan to value ratio on the gross loan, including prepaid interest, or on the projected end balance for capitalised interest. On a property worth $1 million with a 70% limit, the ceiling is $700,000 including interest. That reduces the usable cash compared with a serviced loan at the same ratio.
Which suits which situation
- Serviced suits a trading business with reliable cash flow and a longer term. It is the cheapest overall and keeps the loan amount down.
- Prepaid suits short loans with an event-based exit, such as a sale or settlement. The cost is known and paid on day one.
- Capitalised suits development and construction, where there is no income until the project sells, and the facility is sized to include the interest.
- Part and part is common: a few months prepaid, then serviced.
Terms to check
- Minimum interest period. Some loans charge a minimum of two or three months’ interest even if repaid sooner.
- Rebate on early repayment. Whether unused prepaid interest is refunded.
- Default. If prepaid interest runs out and the loan is not repaid, the higher default rate usually starts immediately. See default interest rates.
- Tax timing. Prepaid interest can have different deduction timing. See is private loan interest tax deductible.
Comparing offers
Two offers at the same rate can deliver different amounts of cash. Line them up by net advance, total cost and repayment figure, as set out in comparing private loan offers. Standard pricing is on the rates and fees page.
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Get matched with a funderFAQ
If I repay early, do I get prepaid interest back?
Often yes for the unused months, subject to any minimum interest period in the contract. Check this term before signing.
Is capitalised interest more expensive?
Slightly, because interest compounds. On a 12 month loan at 1% a month, compounding adds about 0.7% of the loan amount compared with simple interest.
Which do lenders prefer?
For short loans to borrowers without clear monthly cash flow, most private lenders prefer prepaid or capitalised interest, because it removes the risk of a missed payment.