What is Discount Interest?

Sometimes called a front-end loan, discount interest is a type of loan arrangement in which all the interest applied to the loan balance is paid at the time the loan is approved. This is in contrast to the more common approach of applying the interest rate to the outstanding balance at regular intervals during the life of the loan. This approach normally calls for simply withholding the total amount of interest from the approved loan balance from the debtor, reducing the amount of funds that the borrower actually receives. While offered by a number of lenders in various nations around the world, the discount interest arrangement is far less common than the more traditional approach of applying interest to the loan’s balance annually or semi-annually.

A loan structured with discount interest does offer the advantage of being very straightforward in the calculation process. For example, if a borrower is approved for a $1,000 US dollar (USD) loan with terms of repayment that call for the loan to be paid in full in twelve months, the lender will deduct the interest applied to the loan from the initial $1,000 USD. This means that if the interest rate is 10%, the lender will subtract $100 USD from the total loan amount, while providing the borrower with the remaining 90% of the loan, or $900.

One of the advantages of this type of loan arrangement is that all payments made by the borrower go to reduce the principal of the loan. There are no concerns about changes in interest rates due to failing to make a payment on time or dealing with some sort of floating or variable rate of interest on the balance. A borrower may still incur some type of penalty if he or she is late with a payment. Lenders offering discount interest loans often include a schedule of fees for late payments in the terms, effectively motivating borrowers to remit payments in a timely manner.

While a discount interest approach is sometimes a good option, there are no guarantees that retiring the debt early will result in some sort of savings for the borrower. Unlike more traditional loans that apply interest to the balance throughout the life of the loan, there are no provisions for saving on interest by paying off the loan early. For this reason, many consumers who do have availability to this type of loan arrangement prefer to use the discount interest strategy for short-term loans that will be retired within a year, and go with more common loan types when financing a major purchase, like a home or automobile.