RealTown Words

The sum paid or accrued in return for the use of money. Interest is usually stated in terms of an annual rate, although the parties may not always call this payment interest, because it may be disguised in the form of points or mortgage prepayment penalties. Interest on a promissory note is usually charged and due in arrears at the end of each payment period (monthly, semiannually, or as required by the lender).

The maximum rate of interest that may be charged on mortgage loans is often controlled by state law, although there are federal exemptions for home mortgage loans. Charging interest in excess of the statutory loan rate is called usury, and nonexempt lenders are penalized for making usurious loans. In some states, a lender who makes a usurious loan is permitted to collect the borrowed money, but only at the legal rate of interest. In other states a usurious lender may lose the right to collect any interest or may lose the entire loan amount in addition to the interest. Loans made to corporations and FHA and VA loans are generally exempt from state usury laws.

Note that interest (and real property taxes) related to a building’s construction period must be amortized over a ten-year period. Low-income housing continues to be exempt from this capitalization requirement.

Interest rates are quoted for a one-year period. This annual interest amount is divided by 12 to find the interest due for one month. A shortcut to finding one month’s interest charge is to multiply the principal balance of the loan by the interest factor.

Mortgage interest payments on acquiring and improving principal residences and second or vacation homes are fully deductible from income for tax purposes so long as the debt does not exceed $1,000,000. In addition, the discount points paid by a homebuyer are tax deductible in the year of purchase. Interest paid on amounts borrowed against the appreciated equity in first or second homes (“home equity debt”) may not exceed $100,000 in order for the interest thereon to be deductible in full.

Note the difference between nominal interest, the amount (percentage) of annual interest stated in the loan document, and effective interest, the amount of interest the borrower actually pays. The difference usually results from the manner in which the debt is collected, such as the use of discount points to increase the gross rate or principal plus interest (add-on) methods. See the explanation under Truth-in-Lending laws for the difference between interest and annual percentage rate. (See