Deferred Payment Option: Definition and Examples

What Is a Deferred Payment Option?

A deferred payment option is a right to operationally defer (delay) payment on an investment until a later date. In the options market, deferred payment options are a type of exotic option due to the more complex structuring and greater illiquidity than their plain vanilla counterparts. Across the investment industry, several investment vehicles are structured with deferred payment options, most of which are focused on retirement investing. Deferred payments can also apply to loans and mortgages.

Key Takeaways

  • A deferred payment option is a right to operationally defer payment on an investment until a later date.
  • Deferring payment often has certain advantages to paying upfront, such as accruing interest or avoiding opportunity costs, which the owner of that option will usually pay for.
  • Deferred payment options can be structured as a type of exotic option where the premium paid does not have to be paid until the contract's expiration date.
  • Deferred payments also apply to loans and mortgages and are referred to as forbearance.
  • There are many deferred payment investments for retirement, such as deferred payment annuities and individual retirement accounts (IRAs).

How Deferred Payment Options Work

Deferred payment options defer payment until a later date requiring the investor receiving payments to plan for greater illiquidity than standard investments. Deferred payment options in the options market are generally considered to be a type of exotic option due to their complex structuring and alternative market trading.

Broadly, across the investment industry, many investors will choose to invest in deferred payment vehicles since they have certain long-term advantages. In some cases, lenders may also provide a deferred payment option to borrowers under special circumstances such as hardship or academic studies.

Deferred Payment Exotic Options

Deferred payment options are a type of exotic option typically traded on an alternative exchange. Exotic options encompass a broad range of options with more complex structuring than plain vanilla options. As such, the contract agreements and trading terms are negotiated on a per-contract basis. This differs from the offering of plain vanilla options which are listed on public market option exchanges and supported by standardized regulations and market regulators.

A deferred payment option will usually be structured as an American option that defers the option’s payout until the expiration date. A deferred payment option holder can exercise their option at any time during the life of the option, up until the expiration date. The payout from the option is recorded as the amount owed at the time of expiration.

Investors in deferred payment options must consider how the deferred payment will affect their investing plans. If a payout involves receiving an underlying security, the investor will not receive that security until the date of the contract’s expiration. If the payout involves selling a security the investor will not be required to provide the security until the expiration date and they will also not receive the payment until expiration.

Deferred Payment Investments

In the investment industry, investors can choose from a wide range of investments that offer deferred payment. Deferred payment annuities are one of the most common, allowing investors to make contributions and receive regular payouts over a period of time. Individual retirement accounts (IRAs) are also considered deferred payment investments since they offer planned payouts after a specified date.

Deferred Payment Billing

Deferred payment may also be an option for various types of billing cycles. Academic loans are one credit product that offers deferred payments to students with payments beginning after they graduate. Generally, deferred payment options may be a caveat that many service providers offer to their clients giving them extra time to save and meet their obligations.

Deferred Payment vs. Forbearance

Forbearance applies to student loans and mortgages and is a type of deferred payment. A student loan forbearance suspends or lowers student loan payments for a specific period of time—usually 12 months or less—and is provided to qualifying individuals in times of hardship. The Federal government has a variety of forbearance programs for student loans.

During the forbearance period, interest still accrues on the loan and the borrower is responsible for the accrued amount when payments begin again.

A mortgage forbearance applies to a borrower that is in default on their mortgage. In a mortgage forbearance, the borrower and lender come to an agreement where the lender does not exercise their legal right to foreclose on the home and the borrower agrees to a payment plan that will allow them to become current on their mortgage. In a mortgage forbearance, the lender can lower or suspend mortgage payments for a specific period of time.

Examples of a Deferred Payment

Student Loan Deferred Payment

Abby graduated from college five years ago and has student loans in the amount of $20,000. She has been making regular payments on the loans and is up to date. Abby's company loses a large client and has to downsize; Abby loses her job and cannot find work after a few months. She is not able to make payments on her student loans and applies for and is accepted for a student loan forbearance program.

The program allows Abby to defer all principal and interest payments for a period of 10 months; however, in this period, interest continues to accrue on the unpaid balance: $20,000. At the end of the 10 month period, Abby will have to start making principal payments again as well as on the interest that accrued on the unpaid principal amount.

Mortgage Deferred Payment

Mary and Johnny have both had to take pay cuts at their jobs during a financial crisis. They also have a child starting college. They haven't been able to make their mortgage payment for four months and are in default.

In speaking with their bank, Mary and Johnny come to an agreement whereby the bank will not foreclose on their home but have come up with a payment plan for the couple. The bank will defer the mortgage payments for a period of six months.

In those six months, interest will accrue on the principal, and after six months, the couple will start having to make payments, but at 80% of their monthly mortgage. Six months after that, the amount will be raised to the initial mortgage payment.

What Does Payment Deferred on a Student Loan Mean?

A deferred payment on a student loan, also known as forbearance, is when a borrower is allowed to suspend or lower their student loan payments for a specific period of time—usually 12 months. This option is given to borrowers in financial duress, and the government provides a variety of forbearance options.

What Does Deferred Payment Mean in Court?

In court, a deferred payment is when the defendant agrees to pay expenses (fines, costs, and fees) at the end of a stated term. The defendant is not liable for installment payments in such an agreement.

What Does Deferred Payment Mean in Insurance?

In insurance, a deferred payment refers to a deferred payment annuity. This is an insurance product where the purchaser of the annuity receives future payments rather than a stream of income that starts in the present. The payments are "deferred" in that they begin at a future date.

What Is a Deferred Income Payment on Form 1099?

Deferred income payment on Form 1099 is income that has been received but not yet earned. It can be for goods that have not yet been delivered or services not yet provided. On Form 1099, deferred income is treated as taxable income.

What Is a Deferred Payment on a Balance Sheet?

Deferred payment on a balance sheet is unearned revenue. The revenue is unearned because the good or service has not yet been provided but the money has been received. Deferred income payment is a liability and should be represented as such on a balance sheet as to not confuse it with liquid capital, which could lead to cash flow issues.

The Bottom Line

A deferred payment option is a right to defer payments on an investment till a later date. Deferred payment options are common in retirement plans whereby individuals defer paying taxes till retirement when they are in a lower tax bracket—an important financial benefit. Deferred payments also apply to loans and mortgages whereby borrowers in distress can defer payments for a specific period of time to ease their financial burden.

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