Per diem interest is the daily interest on a loan that occurs outside of the standard repayment period. Per diem interest charges may be incurred if a borrower receives their principal payment and begins the loan repayment period on a day other than the first of the month.
Breaking Down Per Diem Interest
Per diem interest allows for convenience and flexibility in the disbursement of a loan. It is a factor that borrowers must consider in the closing of a loan.
Some lenders will accommodate borrowers by starting a monthly repayment cycle on the day that a loan is issued. If a lender requires that a borrower make payments on a loan on the first day of each month then per diem interest will come into effect for the days leading up to the first full monthly payment cycle. Lenders have some latitude in the structuring of per diem interest payments and may or may not begin amortizing the loan at the time of distribution.
Calculating Per Diem Interest
If a lender requires that a borrower make payments on the first day of the month, then they will calculate per diem interest for the days leading up to the beginning of the first payment cycle. Some lenders may allow a borrower to make a partial per diem interest payment on the first day of the subsequent month after a loan has closed and the principal has been issued. Other lenders may require that a borrower pay the per diem interest at the loan closing.
To calculate the per diem interest, the lender will likely use a daily interest rate to determine a borrower’s daily interest. The lender can then multiply the daily interest by the number of days in the per diem interest period.
For example, take a borrower that has been approved for a $100,000 mortgage loan with a fixed interest rate of 4.75% for 30 years. The borrower’s lender requires that payments begin on the first day of the month following a full month’s repayment cycle. The borrower’s loan is closed, and the principal is distributed on July 29, three days before the first day of the next month. This borrower is required to pay the lender per diem interest at the time of the principal distribution. Using a daily interest rate of 0.013% (0.0475 / 365) the borrower must pay the lender $39 (0.00013 x $100,000 x 3) in per diem interest. A lender can choose whether they add daily principal payments to the per diem interest or begin the loan amortization on the first day of the month.
The borrower’s standard loan cycle begins on August 1 with their first monthly payment due on September 1. The standard payment on September 1 covers interest and principal for the entire month of August.