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 anticipated through 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
A discounted payoff is a business term that may arise in several different scenarios. Most commonly, it is part of a negotiation to pay off a lender for an amount below the outstanding balance due to that lender. It can also be used in certain kinds of business dealings as an incentive to pay off an obligation early. For example, it will cost me $20,000 to pay off my car by December 2025, but if I pay it off now, I will only have to pay $18,500.
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 only 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 payoff amount below the full amount of the obligation as part of a final agreement. In most cases of distressed debt DPOs, the lender takes a loss in the amount 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 may agree to a discounted payoff, while also exercising its right to seize the underlying asset. In some instances, the lender may be able to break even or suffer less of a loss because of the difference in equity value vs. payoff value of the asset being levied. Discounted payoffs, however, are not common in collateral-backed loans.
Discounted payoff may also be available on a credit card. This procedure is a debt settlement and allows you to pay a single negotiated lump sum to pay off the balance of your credit card. It may seem simple, but it will have a severe impact on your credit score and still leaves you open to litigation by your creditor.
If, however, you do choose this route, you can contact your original creditor and offer a settlement amount. Generally, your initial offer should be less than half the balance although creditors will generally expect to settle for at least half in the end. Once an amount is agreed upon, you will receive and execute a settlement agreement and pay the settlement amount. Your agreement and your credit report should state that the account was paid as agreed.
In some business dealings, including certain types of 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 the obligation sooner. Some of the benefits to the lender are receiving cash sooner and lower default risks since payments are made and obligations 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 the bill within 30 days.
Advantages and Disadvantages of Discounted Payoffs
A discounted payoff allows the borrower to get relief from a heavy debt burden and pay it off faster for less than the full amount. It also allows the borrower to avoid bankruptcy even though it will negatively affect the borrower's credit rating. In addition, once the borrower enters into a discounted payoff agreement, the debt will not be charged off or sent to collection. Finally, a discounted payoff avoids the possibility of being sued for debt.
Discounted payoff does have disadvantages, including the adverse effect on your credit score. In addition, there are often rather expensive debt settlement fees, which are not applied to the debt. Further, debt settlement companies often hold your lump-sum payment in escrow for months or years. Further, their agreement may even state that they have no obligation to return the funds to you. Finally, any reduction in your debt is imputed income and, if over $600, will be reported to the IRS. Remember, you do not have to use a debt settlement company; you can negotiate your own discounted payoff.
Pros and Cons of Discounted Payoffs
Relief from pressure of being in debt
Avoids charge-off or collections
Avoid being sued for debt
If used debt settlement company, can pay high fees
Adverse impact on credit score
Debt may not be paid off promptly by settlement company
Debt settlement can create imputed taxable income
Example of Discounted Payoff
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 prevent continuing 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. However, it still leaves the borrower with an outstanding balance, often in a larger amount at a higher interest rate than previously held.
The DPO amount will usually form the new liability for the collateral property. Bridge lenders may also require the borrower to pump in a substantial amount of additional equity into the asset, in order to provide a sufficient margin of safety on the bridge loan.
The Bottom Line
Discounted payoffs off advantages and disadvantages. Essentially, you can get out of debt sooner without bankruptcy, but will still suffer an impact to your credit score and potential taxable income.
Discount Payoff FAQs
What Is a Discounted Payoff Agreement?
A discount payoff agreement is an agreement between a debtor and creditor, allowing the debtor to pay off the outstanding balance of a debt for less than the original amount. The agreement will include the amount and timing of the payoff, and include any conditions negotiated by the parties.
How Do You Negotiate a Discount Mortgage Payoff?
It is possible to negotiate a discounted payoff on a second mortgage, sometimes with a drastic discount. If your home is worth less than the amount of its first mortgage, the second mortgage is legally unsecured.
In this case, you can often negotiate a settlement for pennies on the dollar. Explain that you are unable to pay and request a payoff figure. Respond with a figure you can afford and provide evidence that your home is underwater. Remind the lender that foreclosure might be less profitable.
What's the Difference Between a Discounted Payoff and a Maturiity Extension?
A discounted payoff reduces the total amount of money to be paid back and may change the terms of the payback such as the due date. On a maturity extension, there is no reduction in the amount owed, just an extension of the time you have to pay it back.