what is unearned interest 
unearned interest is interest that has been collected on a loan by a lending institution but has not yet been recognized as income or earnings instead it is initially recorded as a liability if the loan is paid off early the unearned interest portion must be returned to the borrower unearned interest is also called unearned discount breaking down unearned interestinterest recorded in the books of financial institutions as a result of lending activities is either earned or unearned earned interest as the name implies is interest income that is earned over a specific period of time from investments that pay the lender a regular series of mandated payments interest earned can be generated from bonds through interest payments made to bondholders after a stated period of time unearned interest has been collected but is not recognized as income or earnings it is initially recorded as a liability not all interest that is received by a lender is earned most lenders schedule loan payments to be made at the beginning of the month the interest paid by borrowers to compensate lenders for lending them funds for a specified period of time represents interest income to the lender however the interest paid by the borrower at the beginning of the month applies to the cost of borrowing for the entire month and therefore has not been earned by the lender for example assume a borrower on the first of each month makes his regular 1 200 payment on a loan of which 240 is the interest portion the 240 is the borrower s cost for making use of the loan for the entire month since he prepaid the interest the 240 will not be earned by the lending institution because the principal of the loan has not been outstanding long enough to recognize this transaction the cash account is debited increase in cash and the unearned interest income account on the ledger is credited this shows that the bank records such income but recognizes the interest portion as unearned if the loan is paid off early the unearned portion must be returned to the borrower for example assume a borrower takes out a 36 month loan on a car if she pays off the entire loan after 30 months she will be refunded 6 months interest unearned this is the amount she will save by paying off the loan early amortization of unearned interestunearned interest is an accounting method used by lending institutions to deal with long term fixed income securities initially recorded as a liability the unearned interest will eventually be recorded as income in the lending institution s books over the life of the loan as time passes and the interest is earned this accounting process is referred to as amortizing unearned interest 