How to calculate per diem interest

Many loan payments are based on per diem interest, meaning interest accrues daily. Most of the time, you don’t think about this because you pay whatever is due at the end of the month. But some loans, including mortgages, require paying interest between the closing and first payment date. To know what you owe, you need to know how to calculate per diem interest.

What is per diem interest?

Per diem interest is the amount of interest that accrues, or builds up, every day on your loan balance. Per diem is originally Latin for “daily” or “by the day.” In the context of lending or investment, per diem interest is used when interest compounds daily to get to the annual interest rate.

How does per diem interest work on a mortgage?

When you close on a mortgage loan, your first payment isn’t due until the 1^st of the month in the first full month after you close. So if you close on June 29, your first payment would be due August 1.

However, mortgage interest starts accumulating the instant you move into your home. Mortgage interest is always paid in arrears, which is just a fancy word for after-the-fact. So if you make a payment on July 1, you’re actually paying interest for all of June. But we just said you wouldn’t have a July payment. So where does that get accounted for?

When you close in the middle of the month, you’re charged per diem interest at closing for the days leading up to the end of the month. In this case, because you close on June 29, you’re charged daily interest for the 29^th and 30^th. Then your August 1 payment accounts for all the interest you owe for July. On September 1, you’ll pay for August interest and so on.

This leads to a quirk in the mortgage process. When you close on your home, you might have the option to start your payment on the 1^st of the following month or the month after. At close, you’re paying the daily interest up until the date of the first payment. Whether you’ll be given an option depends on when you close due to mortgage investor policy on per diem interest limits.

If you do have the option, when is the best time to close on a house? That really depends on your financial situation and goals. Let’s play out two scenarios:

If you close closer to the beginning of the month, you’ll pay more in per diem interest, but you don’t have to make another payment on your mortgage for almost 2 months. Some people like this if they need a month with a little more play in the budget, maybe for buying furniture or gifts around the holidays.

The downside to this is that you’re paying more in interest on the loan by covering so much prepaid interest up front. And 28 or 29 days of interest can really add up, particularly at the beginning of the loan when it’s the most interest you’re ever going to pay.

The second scenario involves closing later in the month. Let’s say you close on the 29^th of a 30-day month. You pay per diem interest for the 29^th and 30^th. Then a month still goes by before your first payment is due, but that first payment covers the month prior. The first payment comes faster, but based on per diem interest, you’re paying less interest over the life of the loan.

A secondary benefit of closing later in the month and starting your payment sooner is that it lowers the closing cost for you. There’s less per diem interest to pay.

Per diem interest also comes into play when you’re paying off a mortgage. When you request a payoff quote, you’ll receive this quote with your payoff amount. That quote will be good for a certain number of days.

If you pay off the loan before the date listed, you’re refunded the per diem interest between the date listed on your payoff quote and when you actually sent the funds to your lender.

How to calculate per diem interest: 4 steps to follow

Knowing the per diem interest you’ll pay can help you know how much money to bring to the table. You may think it’s complicated, but once you see how it’s done, you may realize that calculating per diem interest isn’t as intimidating as you think. Here are the steps:

1. Multiply loan amount by interest rate

The first thing you need to do is multiply the loan amount by your interest rate. To do this, be sure to convert the interest rate percentage to a decimal. You’ll get the interest amount you pay on your loan over the course of the first year. This goes down over time because your balance drops with each payment, but per diem interest for your closing costs is based on the loan amount.

2. Divide annual interest by 360

Once you have your total interest for the first year calculated, the next step is to convert that into a daily interest charge. Do this by dividing the total interest by 360.

3. Count days between closing and first of the month

The next step is to count the number of days between your closing date and the first of the following month. Remember that this isn’t the same as your first mortgage payment due date. Your initial mortgage payment isn’t due until you’ve been in the house for your first full month. The first payment covers that month of interest.

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

The final step is to multiply the daily interest charge you came up with in step 2 by the number of days between your closing date and the first of the month, determined in step 3. This gives you the per diem interest you can expect to pay at closing. If you’re interested in a longer timeframe before the first payment, aim to close earlier in the month. But closing later on could lower costs.

Per diem interest formula

Here is the formula of the above-mentioned steps to quickly calculate per diem interest:

Loan Amount × Interest Rate ÷ 360 × Days Between Closing And The First Of The Month

Example of per diem interest

All of this makes a lot more sense if we put actual numbers to things. Let’s do that now.

Let’s assume you have a $250,000 loan amount at a 6.5% interest rate. Your closing date is June 24. Here’s how to do the calculation for this situation:

1. Loan Amount Multiplied by Interest Rate: $250,000 × 0.065 = $16,250
2. Total interest divided by 360: $16,250 ÷ 360 = $44.52
3. Number of days between June 24 and July 1: 7
4. Multiply daily interest by the number of days between closing and the first of the month: $45.14 x 7 = $315.98

Substituting these into the formula nets the same result:

$250,000 × 0.065 ÷ 360 × 7 = $315.98

Does every lender charge per diem interest?

Per diem interest is commonly charged by mortgage lenders. However, depending on how much per diem interest you owe, you may be able to get a credit from your lender effectively lowering or eliminating this particular charge.

Depending on the type of loan you have, you could also be charged based on simple interest. In this case, you’re not worried about per diem interest because there’s no compound interest at all.

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

Per diem interest is the amount of interest paid daily on a loan. In the context of mortgages, it’s used to account for the period after closing but before your first full month in the home. You pay per diem interest on the time between when you close and the first of the month. After that, the interest is paid as normal in your monthly payment.

Per diem interest is calculated by multiplying the loan amount by the annual interest rate and dividing by 360 before multiplying by the number of days before the first of the month. Doing the calculation can help you understand how much you need to bring for closing.

If you’re getting ready to buy or refinance, learn more about closing costs. If you’re ready to get started, you can apply online or give us a call at (833) 326-6018.