Yield Spread Premium Deductible Loan Fee

Loan origination fees are not tax deductible as “loan origination fees”, nor are they tax deductible as points.  Yes, some direct lending institution’s “loan origination” fees are directly tied to and meet the definition of tax deductible “points”, but again, loan origination fees themselves are not tax deductible.

The IRS defines deductible points as any “points” that are paid for the use of money or otherwise qualify as a payment of interest which is why the misconception exists that loan origination fees as a whole are tax deductible; they may be in part tax deductible.  To get more information, refer to IRS Publications 535 and 936.  Here are the core basics:

• Schedule A deductions only apply to primary and some secondary residences.

• “Points” paid must be common in the area where the property is located and the amount deducted does not exceed the “points” typically paid.

• The “points” are not used by the lender to pay inspection, title, or other fees.

• The borrower pays the “points” upfront; if amortized over the life of the loan then they are only partially deductible over the life of the loan – up to a maximum of 30 years.

• The mortgage loan was used to build or buy the qualifying residence – refinance transactions are subject to limitations.

• The “points” paid are for the use of money and qualify as a payment of interest.

• Additional helpful information may also be found on Form 6251.

A yield spread premium (or YSP) is a result of an above PAR interest rate to a borrower – an increased interest rate = an increased yield on the amount the lender will collect over the life of the mortgage.  An increased yield is expressed in the form of a higher interest rate that a consumer may use to cover some or all of the settlement closing costs (i.e., origination fees, title fees, appraisal fees, escrow/closing agent fees, etc.).  This type of situation is sometimes referred to as a “no origination” or “no cost” mortgage.

Say a borrower goes to a lender to finance the purchase of a $100,000 home with a $20,000 down payment.

The borrower, through the application process, learns that they will need an additional $5,000 to cover settlement closing costs/fees.  They only have an additional $3,000 saved and will be short $2,000 to complete the purchase transaction.  The lender discloses that if a higher interest rate is accepted by the borrower, the lender will credit back to the borrower a similar dollar value.  In this example and for illustrative purposes only, say that the lender’s PAR or base interest rate was 5.00%, but that if the borrower was willing to accept a 6.00% interest rate, they would receive a 2% (or $2,000) yield spread premium credited at closing from the lender.  So, YSP is closer to item #3 listed above as it is used as a credit to the borrower to offset some or all of the settlement closing costs.

To clarify any misconception that there is no relationship to tax deductible mortgage interest (reported on form 1098) and YSP, one must realize that YSP created a higher interest rate.  When a higher interest rate is created, the borrower’s annual deductible mortgage interest will also increase.  Using this same scenario from the prior paragraph, and adding that the borrower’s first 12 mortgage payments ran from January 2009 through December 2009, the amount of interest paid in the first tax year would be: $100,000 Loan Amount$100,000 Loan Amount30 Year Amortization Paid Monthly30 Year Amortization Paid Monthly5.00% Interest Rate6.00% Interest Rate$536.82 Monthly Principal/Interest Payment$599.55 Monthly Principal/Interest Payment$98,524.63 Unpaid Balance (12/09)$98,877.15 Unpaid Balance (12/09)$4,966.49 Total Interest Paid (2009)$5,966.59 Total Interest Paid (2009) By receiving $2,000 in YSP at loan closing for accepting a higher interest rate, the borrower will increase their tax deductible mortgage interest $1,000.10 after the first 12 monthly payments were made in 2009.  [This assumes that the first payment due date was January 1, 2009 and the 12th payment due date was December 1, 2009 – all payments were made on the first day of each month or at least no late payment charges were paid.]