What Is a Discounted Payoff (DPO)?
A discounted payoff (DPO) is the repayment of an obligation for less than the principal balance. Discounted payoffs often occur in distressed loan scenarios but they can also be included as contract clauses in other types of business dealings.
- A discounted payoff is the repayment of an obligation for less than the principal balance.
- DPOs often arise with distressed debt scenarios.
- DPOs are usually a last resort for lenders because they often involve taking a loss.
- DPOs can also be part of a contractual agreement that allows a borrower to pay off an obligation early as an incentive with no negative repercussions.
Understanding a Discounted Payoff
Discounted payoff is a business term that may arise in several different scenarios. Most commonly it can be part of a negotiation to pay off a lender for an amount below the total balance due. It can also be used in some business dealings as an incentive to pay off an obligation early.
A DPO can be one alternative for resolving issues involving delinquent debt. In the case of delinquent debt, the lender will usually agree to a DPO after all other options have been exhausted. In some cases a DPO may also be part of a bankruptcy court settlement in which an order is delivered for a pay off amount below the obligation as part of a final agreement. In most cases of distressed debt DPOs, the lender takes a loss for the value of the contracted debt and interest that the borrower is no longer obligated to pay.
Collateral backed loans that end in a DPO offer a special case for settlement since they have collateral which reduces the risks for the lender. With an asset-backed loan DPO the lender can agree to a discounted payoff level while also exercising the right to seize the underlying asset. In some instances the lender may be able to break even or take less of a loss because of the difference in equity value vs. payoff value of the asset being levied.
In some business dealings, including loan agreements, a lender may include a contract clause that offers a borrower a discounted payoff with no repercussions. In these instances the DPO serves as an incentive for the borrower to pay off their obligations sooner. Some of the benefits to the lender are more upfront cash received and lower default risks since payments are made and obligations are met in a shorter time frame.
Some accounts payable contracts may also fall under the DPO category. For instance, a seller may include terms like 10 net 30 which gives the buyer a 10% discount for paying their bill within 30 days.
Discounted Payoff Example
Each DPO will have its own circumstances and terms. DPOs can be beneficial when they offer a borrower or buyer an advantage. Oftentimes though they are negotiated to stop negative credit history or reach a final debt settlement. Once a distressed DPO has been negotiated between a borrower and lender, the borrower usually has to raise the capital to pay off the loan in a lump sum payment by a specified date in the near future.
One example of a situation where a discounted payoff can be especially useful in utilizing is in the involvement of a third-party bridge lender. A bridge loan involves a third party who provides the cash to the borrower to pay off the DPO while also extending additional capital with new terms. This scenario can be helpful when maintaining collateral is important but it still leaves the borrower with an outstanding balance, often at a higher interest rate than previously held. The DPO amount will usually form the new liability for the property. Bridge lenders may also require the borrower to pump in a substantial amount of equity into the asset, in order to have a sufficient margin of safety on the bridge loan.