Legal Definitions - prepaid interest

Prepaid interest refers to interest payments made by a borrower before they are contractually due. This often occurs at the beginning of a loan term, covering a future period, or as part of the loan's initial setup.

• Example 1: Mortgage Closing

  Imagine a person buys a house and closes on their mortgage on November 10th. Mortgage payments are typically made in arrears, meaning the payment due on January 1st covers the interest accrued during December. However, at closing, the lender requires the buyer to pay the interest that will accrue from November 10th to November 30th.

  Explanation: This payment for the partial month of November is "prepaid interest" because it covers interest for a period *before* the first full monthly payment is due. The buyer is paying this portion of the interest upfront at the time the loan is finalized.

• Example 2: Discounted Small Business Loan

  A small business secures a short-term loan of $75,000 for nine months. Instead of making monthly interest payments, the lender structures the loan so that the entire nine months' worth of interest, say $6,000, is deducted from the principal amount at the time of disbursement. The business, therefore, receives $69,000 but is obligated to repay the full $75,000.

  Explanation: In this scenario, the $6,000 in interest is "prepaid" because it is paid (deducted) at the very beginning of the loan term, covering the interest for the entire nine-month period upfront, rather than being paid incrementally over time.

• Example 3: Personal Loan with Initial Interest Payment

  A consumer takes out a personal loan for home renovations. The loan agreement specifies that the first payment, due one month after disbursement, will consist solely of interest for that initial month. Principal payments will begin with the second scheduled payment.

  Explanation: The interest paid in the first installment is "prepaid interest" because it covers the interest for the period immediately following the loan's disbursement, effectively paying for the use of the money for that initial month upfront, before the regular principal and interest repayment schedule fully kicks in.