What is per diem interest? How it works and why it’s charged

When applying for a mortgage, you might be thinking ahead to the 15 or 30 years you’ll spend repaying it. But, when you actually get the mortgage, you’ll also want to pay attention to a much shorter time frame, or rather window — the window in which you accrue per diem interest.

Per diem interest is the daily interest charged on a home loan for a brief time. It may not amount to a lot, but the concept is important for determining your interest costs between your closing day and the day you’ll start regularly repaying your mortgage. Here’s what you need to know.

What is per diem interest?

Per diem interest just means daily interest (“diem” is Latin for “day”). In the home financing world, it specifically applies to the interest you’ll pay in the period between the closing of your loan (and your home purchase) and the beginning of your standard monthly mortgage payments.

Billing cycles for a mortgage usually start on the first day of the month. But mortgages can get finalized on any (business) day of the month. If the timing of the closing doesn’t fit neatly with the first of the month, you’ll still need the principal amount to get the deal done, and your mortgage lender still needs to charge you for borrowing the money.

That’s where per diem interest comes into play. It’s the amount of interest, based on your mortgage rate but literally calculated by the day, that you’ll pay for the time in-between your closing date and the beginning of the next billing cycle.

For example, if your closing is on May 20, there is an 11-day gap until the monthly payment cycle begins (mortgage payments typically being due the first day of the month). You’ll pay per diem interest during those 11 days.

How does per diem interest work?

Your per diem charges will be collected as prepaid charges (which are technically separate from closing costs). By prepaying them, you’ll avoid letting the amount grow due to compounding.You can add up the per diem costs to know how much you’ll pay in interest before receiving your regular mortgage bill.

Per diem interest example

Say you’re taking out a mortgage of $400,000 to buy your home, and the interest rate is 6 percent. Your closing date is five days before the first of the month, and your lender requires per diem interest to cover that gap. Here’s how the math breaks down:

1. Multiply your loan amount by the interest rate: $400,000 x 0.06 = $24,000
2. Divide the interest by 365 to find the daily rate: $24,000 / 365 = $65.75
3. Multiply the daily rate by the number of days between your closing date and the first day of the month: $65.75 x 5 = $328.75

This gives you the amount of per diem interest you will need to pay. In this example, the total per diem interest is $328.75.

Once the next month begins, you won’t need to worry about per diem expenses anymore. Instead, you’ll start seeing a bill for the standard monthly payment that was spelled out in your closing disclosure.

Does per diem interest vary by lender?

As you compare mortgage lenders, you’ll find a wide range of policies when it comes to per diem interest. For example:

• Many will ask for your per diem payments upfront, in a lump sum.
• Some will roll your per diem charges into your first payment.
• Others won’t even bother to charge per diem interest.

This difference in policies is another reason why it’s crucial to compare different lenders to find the best deal. Once you settle on a lender and pick a closing date, verify how the institution handles per diem costs.

Per diem interest is not a huge amount, but it can be a jolt if you aren’t prepared for it, and are feeling strapped from your down payment and closing costs.

How to limit your per diem interest costs

As you look ahead to the day when the keys to the new house are officially yours, make sure you have a grasp on what you’ll need to budget for per diem interest. These additional daily interest charges can increase the amount you owe at closing, or on your first mortgage payment. If you want to limit your per diem interest costs, consider working with the seller to arrange a closing date at the very end of the month.

 Additional reporting by Emma Woodward