When applying for a mortgage, you might be thinking ahead to the 15 or 30 years you’ll spend repaying it. You’ll also want to pay attention to a much shorter time frame: the window you accrue per diem interest.
What is per diem interest?
Per diem interest describes the amount of interest you’ll pay each day for your mortgage. (“Diem” is Latin for “day.”) The concept is important for determining your interest costs between your closing day and the day you’ll start making standard monthly payments.
For example, if your closing day is May 20, there is an 11-day gap until the monthly payment cycle begins. You’ll still need the principal amount to get the deal done, and the lender needs to start charging you for the loan. You can add up the per diem costs to know how much you’ll pay in interest before receiving your regular mortgage bill.
How does per diem interest work?
If the timing of the closing on the mortgage doesn’t fit neatly with the first of the month, your mortgage lender still needs to charge you for borrowing the money. That’s where per diem comes into play. 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.
Per diem interest example
Say you’re taking out a mortgage of $400,000 to buy your home, and the interest rate is 5 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:
|Loan amount||Fixed interest rate||Daily interest||Total per diem charges|
|$400,000||5%||($400,000 x .05)/365 = $54.79||$273.95|
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. Many will ask for your upfront per diem payments in a lump sum. Others might not even bother to charge per diem interest, or they might roll your per diem charges into your first payment. 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 what to expect with your per diem costs.
Per diem interest can increase the amount you owe at closing, depending on your timing. As you look ahead to the final day before the keys are officially yours, make sure you have a grasp on what you’ll need to budget for additional daily interest charges. 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.