What Is Per Diem Interest on a Car Loan?
Understand per diem interest on car loans. Learn how daily interest calculations affect your payments, payoff, and overall loan cost.
When financing a vehicle, understanding how interest is calculated is key to grasping the total cost of a car loan. Per diem interest refers to the daily accrual of interest on the outstanding loan balance. This concept helps explain how the total interest paid can fluctuate based on payment timing and other financial decisions.
Defining Per Diem Interest
“Per diem” is a Latin phrase meaning “per day.” In the context of a car loan, per diem interest is the amount of interest that accumulates on your loan each day. Most car loans operate on a simple interest basis, meaning interest is calculated solely on the current outstanding principal balance. This daily calculation ensures the interest charge accurately reflects the precise amount owed. Lenders calculate interest this way to account for the exact period money is borrowed, which can vary slightly between payments or in scenarios like early payoffs.
Calculating Per Diem Interest
Calculating per diem interest involves a straightforward formula. To determine the daily interest amount, take your outstanding principal balance and multiply it by your annual interest rate, then divide the result by 365 days (or 366 in a leap year). For instance, if you have a car loan with an outstanding principal balance of $15,000 and an annual interest rate of 6%, the daily interest calculation would be ($15,000 0.06) / 365, which equals approximately $2.47 per day. As the principal balance decreases with payments, the daily interest amount will also decrease.
Scenarios Where Per Diem Interest Matters
Understanding per diem interest becomes important in several common car loan scenarios. When considering an early payoff, for example, the exact amount required to close the loan changes daily. A lender’s payoff quote will include a “good through” date, and if the payment is made after this date, additional per diem interest will have accrued, increasing the final amount due.
Similarly, during a car loan refinancing, per diem interest affects the precise amount needed to pay off the original loan. The new lender will need to know the exact payoff amount on the day the refinance is finalized. Any delay in the payoff process, even by a few days, will result in additional per diem interest on the old loan, which must be covered to complete the transaction. This highlights the importance of coordinating closing dates carefully.
Making extra principal payments is another area where per diem interest plays a significant role. When you pay more than your scheduled monthly amount and direct the additional funds specifically towards the principal, you immediately reduce the outstanding loan balance. Because interest is calculated daily on this principal balance, a lower balance means less interest accrues each day going forward. This strategy can lead to substantial interest savings over the loan’s term and help pay off the car loan sooner than initially scheduled. It is advisable to confirm with your lender how extra payments are applied, as some may not automatically go to principal.