Loan fees and the effective interest rate

Banks earn significant fees when they make loans, and how those fees are recognised changes reported income for years. This guide explains which fees and costs go into the effective interest rate, works through a five-year loan, and covers commitment fees, syndication fees and the effect of expected prepayments.

By Awais Jameel, Chartered Accountant. Reviewed by Muhammad Bilal, Chartered Accountant. 3 minute read.

Short answer

Loan origination fees, such as arrangement fees charged to borrowers, are not income on the day a bank receives them. Under IFRS 9, fees that are an integral part of the loan's yield, net of directly attributable origination costs, are included in the effective interest rate and recognised as interest income over the loan's expected life. In this guide's example, a 2% arrangement fee less 5,000 of direct costs on a 1,000,000 five-year loan at 6% raises the effective interest rate to 6.36%. Fees for separate services fall under IFRS 15 instead.

At a glance

Integral fees
Spread through the effective interest rate
Direct origination costs
Deducted, also spread
Service fees
IFRS 15, when the service is given
Commitment fees
Deferred if drawdown is probable
Expected life
Includes expected prepayments
Presented in
Net interest income
Loan fees and the effective interest rateIntegral fees: Spread through the effective interest rate; Direct origination costs: Deducted, also spread; Service fees: IFRS 15, when the service is given; Commitment fees: Deferred if drawdown is probable; Expected life: Includes expected prepayments; Presented in: Net interest income.KEY FACTS AT A GLANCELoan fees and the effective interest rateIntegral feesSpread through theeffective interest rateDirect origination costsDeducted, also spreadService feesIFRS 15, when the serviceis givenCommitment feesDeferred if drawdown isprobableExpected lifeIncludes expectedprepaymentsPresented inNet interest incomeTax BakersLoan fees and the effective interest rateIntegral fees: Spread through the effective interest rate; Direct origination costs: Deducted, also spread; Service fees: IFRS 15, when the service is given; Commitment fees: Deferred if drawdown is probable; Expected life: Includes expected prepayments; Presented in: Net interest income.KEY FACTS AT A GLANCELoan fees and the effectiveinterest rateIntegral feesSpread through the effective interest rateDirect origination costsDeducted, also spreadService feesIFRS 15, when the service is givenCommitment feesDeferred if drawdown is probableExpected lifeIncludes expected prepaymentsPresented inNet interest incomeTax Bakers
Key facts at a glance, as set out in this guide.

A loan origination fees example

A bank lends 1,000,000 for 5 years at 6% interest, paid annually, with the principal repaid at the end. It charges a 2% arrangement fee of 20,000 and pays 5,000 of directly attributable origination costs, such as a broker's commission and legal fees. The net fee of 15,000 reduces the loan's initial carrying amount to 985,000, and the effective interest rate is the rate that discounts the loan's cash flows back to that amount: 6.36%.

YearOpening carrying amountInterest income at 6.36%Cash interest at 6%Fee released
1985,00062,64260,0002,642
2987,64262,81060,0002,810
3990,45262,98960,0002,989
4993,44063,17960,0003,179
5996,61963,38160,0003,381
Interest income vs cash interest by yearInterest income vs cash interest by year62,64260,000Year 162,81060,000Year 262,98960,000Year 363,17960,000Year 463,38160,000Year 5Interest incomeCash interest
The net fee is spread across the loan's life.

The net fee of 15,000 is released over five years as extra interest income, not recognised upfront, and most of it in the early years when the balance outstanding is highest. Total interest income over the loan's life is 315,000: the 300,000 of cash interest plus the net fee.

Which fees go into the effective interest rate?

  • Included: arrangement and origination fees, fees for evaluating the borrower's financial position, negotiating terms and preparing documents, and directly attributable transaction costs, such as broker commissions.
  • Excluded, IFRS 15: fees for services provided separately, such as account maintenance, loan servicing for others, and advisory work.
  • Excluded, expensed: internal costs that would be incurred anyway, such as general overheads and the salaries of staff not directly involved.

How are loan commitment fees treated?

If it is probable that the borrower will draw down the loan, a commitment fee is deferred and included in the effective interest rate of the loan when drawn. If drawdown is not probable, the fee is recognised over the commitment period. Fees on revolving facilities that are mostly undrawn are often recognised over time on this basis.

What about syndication fees?

A bank that arranges a syndicated loan and keeps no part of it, or keeps a part at the same effective interest rate as the other lenders, recognises the syndication fee as revenue when the syndication is complete. If it keeps a part at a lower rate than the others, part of the fee is effectively compensation for that and is included in its effective interest rate.

How do expected prepayments affect the rate?

The effective interest rate is based on the expected life of the loan, including expected prepayments. Mortgages repaid on average after five years, not their 25-year term, have fees spread over about five years. When prepayment expectations change, the carrying amount is recalculated at the original effective rate, with the adjustment in profit or loss. Teaser rates and cashback offers on mortgages are included in the same way, as part of the yield over the expected life.

What are common mistakes?

Recognising arrangement fees upfront as fee income; including internal costs that are not incremental; and using the contractual term instead of the expected life for products that are usually repaid early. See the effective interest method and bank accounting.

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Questions people ask

How are loan origination fees accounted for under IFRS 9?

Fees integral to the loan's yield, net of direct origination costs, are included in the effective interest rate and recognised as interest income over the loan's expected life.

Are loan arrangement fees revenue under IFRS 15?

No. Fees that are an integral part of the effective interest rate are within IFRS 9; only fees for separate services fall under IFRS 15.

How are commitment fees treated?

Deferred and included in the loan's effective interest rate if drawdown is probable; otherwise recognised over the commitment period.

Which origination costs can be included?

Only directly attributable incremental costs, such as broker commissions and legal fees, not general overheads.

Sources

Every fee, date and rule on this page was taken from these official and primary sources.

  1. IFRS Foundation: IFRS 9 Financial Instruments

Rules and fees change. If you are reading this long after October 4, 2026, confirm the figures with the source before you rely on them.

IFRS 9Amortised cost and the effective interest method under IFRS 9BankingBank accounting: the key IFRS issuesBankingForbearance and loan modifications

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This guide is general information. It is not tax or legal advice for your situation.