What Is Odd-Days Interest?
Odd-days interest is the interest due on a mortgage loan to cover an initial, partial month's payment before the regular monthly payments begin. An odd-days interest payment can occur when a mortgage loan's payments are scheduled to be due on the first of every month. However, the mortgage closingoccurs on any weekday during the month.
Moreover, closings can get delayed for several reasons, affecting the amount of interest due at the closing. As a result, most mortgage loans include an odd-days interest payment, which is also called interim interest, prepaid interest, or per diem interest.
Key Takeaways
- Odd-days interest refers to the interest due on a loan before the first regular payment starts.
- An odd-days interest payment can be necessary when a loan closing falls on a different day of the month than when the regular payments are due.
- There are several different ways that lenders may require borrowers to pay the interest shortfall.
- Odd-days interest also goes by other names, including interim interest, prepaid interest, and per diem interest.
Understanding Odd-Days Interest
Odd-days interest is necessary because there are no free-of-interest days in an installment loan. The amortization of theprincipal loan amountisspread across the scheduled monthly payments for the term of the note. However, the mortgage interest clock starts ticking as soon as funds transfer to the borrower. The calculations for odd-days interest do not include any principal payment.
How Odd-Days Interest Works
The debt that accumulatesduring the odd-days interest period, between the settlementof the loan and the beginning of the first full payment month, is known as the interest shortfall. It can be paid in one of three ways:
- "With origination"means the shortfall is due at the time of the closing
- "With first"means the shortfall is due with the first regular monthly payment
- "Amortized" means the shortfallwill be spread out over the length of the loan, making all payments slightly higher
The interim interest shortfall payment can be either a"long-first-period" or "short-first-period" payment. The type will dependon the language of the contract and when the closing takes place.
Long-first Period
In a long-first-period, the closing occurs before the first regular month of the loan. For example, the Smith family has aclosing on Sept. 20, with their first full month's mortgage payment for October due on Nov. 1. The Smiths will owe an interestshortfall for the last 10 days in September (21-30).
Short-first Period
In a short-first-period, the closing comes after the first of the month listed on the contract as the first regular payment period. In this case, suppose the title company delays the Smiths'closing until Oct. 11. Now, the Smiths are entitled to a refund of interest for the first 10 days in October.
Here, the mortgage lender might reduce the first monthly payment, amortize the reduction over all the loanpayments, or apply it to the principal balance. If it is deducted from the principal balance, it will slightlyreduce the monthly payments.
Special Considerations
A common problem for both borrowers and lenders is the unpredictability of the loan's closing date. Several factors can cause the closing date to get moved. As a result, knowing the exact amount of odd-days interest due at closingcan be challenging. However, mortgage lenders should be able to tell borrowers how they plan to calculate and adjust for the interim interest payment.
Mortgage lending discrimination is illegal.If you think you’ve been discriminated againstbased on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report, either with theConsumer Financial Protection Bureauor theU.S. Department of Housing and Urban Development (HUD).
Is Odd-Days Interest Tax Deductible?
According to the Internal Revenue Service, prepaid interest (of which odd-days interest is an example) is deductible but must be allocated to the tax years to which the interest applies. So, the IRS says, "if you pay interest in advance for a period that goes beyond the end of the tax year, you must spread this interest over the tax years to which it applies."
Your lender should report the total amount of interest you paid for the year on the Form 1098, Mortgage Interest Statement that it sends you at the end of each year. Interest is also deductible only if you itemize your deductions rather than taking the standard deduction.
What Are Other Forms of Prepaid Interest?
In addition to odd-days interest, points, also known as discount points, are a common form of prepaid interest associated with mortgages. Points represent interest that a borrower pays the lender upfront to reduce the interest rate on their remaining loan payments. Each point equals 1% of the loan principal.
For example, a borrower who pays two points on a $200,000 mortgage would give the lender an additional $4,000 at closing. The lender would, in turn, reduce the interest rate on the loan. Buyers pay points in order to lower their monthly mortgage payments for years to come.
The Internal Revenue Service allows taxpayers who itemize their deductions on Schedule A of their tax returns to claim points as a deduction in the year they are paid in many cases. Specifically, the IRS instructions say, "You can deduct the points to obtain a mortgage or to refinance your mortgage to pay for home improvements on your principal residence, in the year you pay them, if you use the cash method of accounting. This means you report income in the year you receive it and deduct expenses in the year you pay them."
How Do You Know How Much Interest You Can Deduct?
Your lender is required to provide you with a Form 1098, Mortgage Interest Statement, each year if you paid $600 or more in interest. The $600 threshold includes both regular interest and any points. For example, as the IRS explains in its instructions to lenders, "if a borrower pays points of $300 and other mortgage interest of $300, the lender has received $600 of mortgage interest and must file Form 1098. Report the total points on Form 1098 for the calendar year of closing regardless of the accounting method used to report points for federal income tax purposes."
Form 1098 also contains other information that can be useful to the taxpayer, such as the current outstanding balance on their loan.
The Bottom Line
Odd-days interest represents the interest due at a mortgage closing to cover an initial, partial month's payment before the regular monthly payments begin. An odd-days interest payment can occur when a mortgage loan's payments are due at the beginning of the month but the closing is near the end of the month.
Odd-days interest is one of the many closing costs borrowers can usually expect to pay on a mortgage. Like other mortgage-related interest, it can qualify for a tax deduction.
