Loan Types: Pure Discount, Interest-Only & Amortization

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  • 0:03 Loans Types
  • 0:33 Pure Discount Loans
  • 1:37 Interest-Only Loans
  • 2:42 Amortizing Loans
  • 3:21 Lesson Summary
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Lesson Transcript
Instructor: Ian Lord

Ian has an MBA and is a real estate investor, former health professions educator, and Air Force veteran.

This lesson explores three types of loans: pure discount, interest-only, and amortizing loans. We'll examine how these loans are repaid and how the lender makes a profit.

Loan Types

Ben owns a small real estate investment company that is considering loaning money out to other investors to drum up more business. Before he decides on what kind of loan products to offer, he needs to be aware of different types of loans. Not only will knowing how they work help him sell the loans, it will also help him know how specific products can make money for the company. Let's review three of the major loan types: pure discount, interest-only, and amortizing loans.

Pure Discount Loans

What if Ben wanted to generate funds for investment activity from other investors instead of a bank? A pure discount loan is an option that would have Ben sell a bond at a discount. Ben would issue a note, and the investor would be a note holder. An example would be where Ben sells a $1,000 face value bond for $900 with a two year maturity date. In two years, Ben would give $1,000 to the investor. Ben wouldn't pay the bond holder any interest over those two years; instead the interest is earned when the bond is redeemed, or paid back, at maturity.

How is this a good deal for Ben? By issuing this bond, Ben's effectively borrowing money at 5.4% with no payment due for two years. Ben can then take that money and invest it in other ventures. Any returns beyond the cost of the bond are an additional source of profit. Likewise, as long as the borrower is confident that Ben's company will repay the loan, he or she is guaranteed a specific return on investment.

Interest-Only Loans

What if instead of borrowing money, Ben wants to loan money to other real estate investors? An interest-only loan product could attract buyers who want some limited amount of time to pay just the interest due on a loan without making balance reduction, or principal, payments. This can be a win-win for both Ben and his customer. Ben receives the interest he would have made otherwise - likely more interest than a traditional amortizing loan because he can mark up the interest rate.

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