What Is a Per Diem on a Loan and How Does It Work?
Navigate daily interest charges on loans. Understand how per diem is determined and its effect on your overall borrowing expenses.
Per diem interest on a loan refers to interest charged daily. This calculation compensates lenders for the use of funds from disbursement until regular payment cycles begin, bridging any gap between the loan’s closing date and the first scheduled payment.
Calculating Per Diem Interest
Calculating per diem interest involves a straightforward methodology based on the loan’s principal, its annual interest rate, and the specific number of days in question. The first step requires converting the annual interest rate into a daily rate. This is typically achieved by dividing the annual interest rate by the number of days in a year. While 365 days is common, some lenders may use a 360-day year for calculation purposes, which can slightly impact the daily interest amount.
Once the daily interest rate is determined, it is then multiplied by the current outstanding loan principal. This yields the dollar amount of interest that accrues each day. For example, a $100,000 loan at a 6% annual interest rate (365-day year) has a daily rate of approximately 0.016438%, resulting in $16.44 of interest per day.
To calculate total per diem interest for a specific period, the daily interest amount is multiplied by the number of days interest is charged. This ensures borrowers pay only for the exact number of days they have access to funds. As the principal balance decreases over the life of the loan, the per diem interest amount also gradually reduces.
Key Scenarios for Per Diem Interest
Per diem interest frequently applies in situations where a loan’s funding and its first scheduled payment do not align perfectly with the start of a calendar month. The most common scenario is during the closing of a mortgage or other significant loan. Lenders typically schedule the first full monthly loan payment for the first day of the month following a complete billing cycle.
If a loan closes mid-month, per diem interest covers the period from the closing date through the end of that month. For instance, if a loan closes on June 15th and the first payment is due August 1st, per diem interest is charged for the 16 days remaining in June (June 15th through June 30th).
Other instances include construction loans, where funds are disbursed in draws, or during a loan refinancing. If a new loan funds before the old loan is fully paid off, per diem interest may apply to the new loan for a short period. This mechanism ensures lenders are compensated for the period funds are outstanding before regular payments begin.
Impact on Loan Costs
Per diem interest directly impacts a borrower’s overall financial outlay, particularly at the time of loan closing. This interest charge is usually included as part of the closing costs associated with the loan. It is often itemized on closing documents, such as the Closing Disclosure, under a category like “prepaid interest.”
This charge is distinct from the regular monthly principal and interest payments. Its purpose is to cover the interest accrued during the interim period between the loan’s funding date and the start of the first full monthly payment cycle. By paying this interest upfront, the borrower effectively pre-pays the interest for that initial partial month.
The amount of per diem interest will depend on the loan amount, the interest rate, and the number of days remaining in the month of closing. Understanding this component of closing costs is important for borrowers, as it covers the initial period of interest accrual before the regular amortization schedule begins.