Mortgage Closings and Per Diem Interest

Many home loan borrowers are confused about a charge on their mortgage loan closing statement referred to as per diem interest.  Part of the confusion stems from the fact that this charge is referred to as a closing cost on the good faith estimate provided to the borrower.

Per diem interest means the amount of daily interest payable under a home loan.  The mortgage lender needs to calculate per diem interest in order to determine the amount of interest payable by a borrower at the loan closing.

At the loan closing, this will the daily cost of interest form the time the funds are disbursed to either purchase the home or after the three day right of rescission on a mortgage refinance to the time period when the mortgage interest starts to accrue for the first payment. 

Most all home mortgages have loans monthly payments that cover a 30 day period of time due on the first of the month.  A borrower’s first monthly payment is typically due the first day of the second month after closing.  For example, if a loan closes on January 15, then the first monthly payment will be due on March 1 not February 1.

Interest paid on home loans is payable in arrears, using the above payment date example, the March 1 monthly payment will cover interest which accrued during the month of February.  Normally, rent payments are calculated another way and are forward payments, the March 1 payment covers the rent for the month of March not February.

Following this same example, the borrower that would close on the home loan on January 15 has their first monthly mortgage payment due on March 1, whether the loan was a refinance or for a purchase.  The borrower has a payment due on March 1st that covers all of February’s interest charges and any principal due, but the borrower had access to the funds from the time it disbursed in mid January.  To cover the interest charges from January 15 to the February 1st, at the closing the borrower will have to pay interest covering that period from January 15 through January 31 since this interest will not be included in the March 1 monthly payment.

Per diem interest is determined by first multiplying the principal amount of the loan by the interest rate to determine the annual amount of interest payable under the loan.  Next, the annual amount is divided by 360 days to determine the per diem interest amount (note mortgage lenders typically calculate per diem interest based on a 360 day year; when calculating per diem interest it always divided by 360 days unless the mortgage lender specifically instructs otherwise).  Finally, the per diem interest amount is multiplied by the number of days remaining in the month of closing, including the date of closing.

For example assume that a loan with an original principal amount equal to $100,000 and an annual mortgage interest rate of 7.00% is funded on January 15.  To determine all charges at the closing, the mortgage lender must determine the amount of per diem interest which will be payable by the borrower at closing.

The total annual interest is equal to $7,000 or 100,000 x 7%.  This is interest for the year and therefore has to be divided by 360 to obtain the daily interest of $19.44.  This figure is now multiplied by the 15 days remaining in the month to come up with a total interest charge of $291.60.

This charge will be depicted as a closing cost on the settlement statement but this would seem like a misnomer.  The interest charge is simply the cost of having access to that money before the first mortgage payment, referring to interest charges as a closing cost in the same general category as origination fees can appear confusing.