Per diem interest is the daily interest paid on a loan. Commonly used in mortgages, per diem interest is applied to a mortgage loan at closing or refinancing. It covers the period between the closing date and the day before loan repayment begins.
Knowing how to calculate and when to expect per diem interest charges will help potential borrowers budget for interest fees and thwart any unexpected costs during the closing or refinancing process. Learn how per diem interest works and when you might encounter it.
Definition and Example of Per Diem Interest
Per diem interest is used to charge daily interest for the days that fall between a loan closing date and when repayment is scheduled to begin.
Typically, mortgage lenders require loan payments to be made on the first of the month. That means you are charged interest on the amount you owe for the previous month in addition to your principal balance.
Your first mortgage payment isn’t due until the first full month after you close on a home loan. Therefore, if a loan closes or is refinanced on a day that is not the last day of the month, you will be charged per diem interest for any days leading up to the first full month before the initial repayment date. This amount will be paid at your closing, which is often why it’s considered “pre-paid interest.”
Per diem is a Latin word that translates to “per day,” so per diem interest literally means per-day interest.
For example, if your home closing is April 15, but the lender doesn’t require your first official payment until June 1, you will be charged per diem interest at the closing for the 15 days spanning April 15 to April 30. So, your first official payment—on June 1—will cover May 1 to May 31.
How Per Diem Interest Works
Renters pay rent for the month in advance, whereas home borrowers pay interest on a mortgage loan the month after it has accrued, which is called paying in arrears. Essentially, lenders cannot collect interest on days that haven’t happened yet.
Every day you owe money, you will also owe interest. When it comes to days that may fall outside of the loan term contract or refinancing period, lenders basically pro-rate the days by charging interest per diem.
“Per diem interest affects borrowers because it is another cost they have to come up with upfront,” Khari Washington, mortgage broker and owner of 1st United Realty & Mortgage, told the Balance by email.
“When a borrower refinances a property or buys a property, per-diem interest will be a closing cost they will need to pay,” he said.
Per diem interest is calculated using 1/365 of the annual interest rate. That means if you have a $300,000 mortgage loan at an annual 4% interest rate, you would multiply $300,000 by 4% (expressed in decimal), then divide it by 365.
You would then take that amount and multiply it by the number of days until month-end. In the case of the April 15th home closing mentioned earlier, that would be 15 days.
Here’s an example:
$300,000 x 0.04/365 = $32.88
$32.88 x 15 days = $493.20
The per diem interest charge for the $300,000 home loan you closed on April 15th would be $493.20.
Look for your per diem interest amount on your closing disclosure. This will be the only time you will be asked to pay interest on the loan upfront.
How Per Diem Interest May Affect You
It is important to remember that lenders have varying policies on how they charge per diem interest. Some lenders may start repayment as soon as the loan is issued and skip per diem interest altogether.
It’s best to inquire and review your lender’s process before entering into a loan contract so that you are aware of how per diem interest may or may not affect you.
- Per diem interest is the daily interest charged on a mortgage or refinanced loan.
- Lenders charge per diem interest to cover any gaps between a closing date and the first repayment due date.
- Borrowers usually pay per diem interest fees upfront during the closing process.
- Lenders may charge and calculate per diem interest differently.