How to calculate per diem interest

The finance world has a tradition of using ancient and obscure terms, making some simple concepts more confusing than they need to be. Per diem interest sounds fancy because it’s Latin, but it simply means per day. We’ll define mortgage per diem and how it works.

What is per diem interest?

Per diem interest is interest per day. You could be earning or paying it, depending on the situation. It can show up as the proceeds from savings or an investment, or as payments on a loan.

Per diem versus prepaid interest

Per diem interest often is confused with prepaid interest, which is a prepaid cost. Per diem interest covers the period between closing on your mortgage and your first payment.

Prepaid interest is paid at closing to reduce the interest rate on your loan. This refers to buying mortgage points, also known as discount points. One point costs 1% of the principal and reduces your interest by a specific amount, usually 0.25%. You can buy fractions of a point, down to 0.125 points. Buying points makes sense if you stay in the home long enough that your monthly savings on interest outweigh up-front costs.

How does per diem interest work on a mortgage?

Mortgage interest is paid in arrears, meaning when you make your mortgage payment, you’re paying for the interest that has accrued since your last payment. Because mortgage interest accrues daily, you have to pay interest between your closing date and the dates covered by your first statement at closing.

Let’s say you close your mortgage on June 28. You would pay per diem interest for the period between June 28 – July 1 at closing. Your first payment would be due on Aug. 1 for the period covering July 1 – 31. The first payment comes sooner if you’re on biweekly payments. It would be in July as opposed to August.

This makes the timing of a couple of mortgage events very important if you’re hoping to save money in the process.

To save on closing costs, the best time to close on a home is near the end of the month. This allows you to pay as little per diem interest as possible before dates covered by the first statement.

Per diem interest formula

The formula for per diem interest is straightforward:

Daily interest rate × Loan amount × Days between loan close and the first of the month

How to calculate per diem interest

The best way to get a feel for this is through an example, so let’s start with a scenario:

• Interest rate: 6.81%
• Loan amount: $270,000
• Closing date: June 18

1. Convert to a daily interest rate

The first step is to convert your interest rate to a daily interest rate, which is achieved by dividing the annual interest rate by the number of days in a year. This is either 365 days or 366, depending on whether it’s a leap year and your lender’s practices. It comes out to 0.019%. Converting to a decimal now makes everything easier.

6.81 ÷ 365 ÷ 100 = 0.00019

2. Multiply the loan amount by the interest rate

Multiply the loan amount by the daily interest rate next. This will give you daily interest. Using the numbers in our example, it comes out to $50.38.

$270,000 × 0.00019 = $50.38

3. Count days between closing and the first of the month

You need to count the days between your closing date and the first of the month. Since the closing date is June 18, it is 13 days away.

4. Multiply daily interest by the days between closing and the first of the month

Multiplying the daily interest by the number of days between closing and the first of the month will give you your total per diem interest owed at closing.

13 × $50.38 = $654.94

Because the formula is simple, those of you who are good with spreadsheets can even make a per diem calculator to see the effect of closing on different days has on your cost. I’m going to demonstrate a basic spreadsheet setup and provide the Excel formula for each step.

Columns A and B are formatted as dates. Column C is general formatting. Column E needs to be formatted as a percentage. Columns D, F, and G are formatted as currency. Daily interest is rounded to the nearest cent to match lending standards.

Does every lender charge per diem interest?

Per diem interest is standard because your loan starts on your closing day, and the first statement only covers interest from the first of the month forward. Depending on your lender and the amount of the charge, you may be able to ask the lender to waive the fee or provide a credit toward your per diem interest.

You can find out if and how much you’re being charged by looking at your Closing Disclosure.

FAQ

Here are answers to common questions about per diem interest.

What if my closing is delayed?

If your closing is delayed until later in the month, you may be able to benefit from a lower per diem interest bill. But if your closing is held beyond the first of the month, you could end up paying more. You’ll want to be prompt in returning all paperwork to avoid delays.

Who pays per diem interest?

Because it’s paid at closing, the buyer or the client refinancing can pay or be given a lender credit toward per diem interest. If it’s a purchase, you can also negotiate to have the cost paid by the seller.

Is per diem interest tax-deductible?

Subject to limits, mortgage interest on primary and vacation homes is tax-deductible. Under current IRS rules, you can deduct interest on mortgage limits up to $750,000 if you’re married and filing a joint return or $375,000 if you’re single or married filing separate returns.

The bottom line: Calculating per diem interest can help you budget for closing day

When you close on a mortgage, you pay per diem interest covering the time between closing day and the first of the following month. This is the only time you need to worry about paying forward interest because your mortgage statements are all based on past interest. A key to saving on per diem interest is closing late in the month.

Now you understand how to make your closing work for you. If you’re ready to buy a home or refinance your current one, you can apply online.