When purchasing a home through a mortgage loan, buyers must be prepared for a range of fees and charges, commonly referred to as closing costs. One notable, yet often overlooked, component of these closing costs is per diem interest. Understanding this fee is crucial for prospective homeowners as it can significantly impact the total amount owed at closing. Per diem, which translates to “per day” in Latin, specifically refers to the daily interest that homeowners must pay on their mortgage loan from the closing date until the due date of their first mortgage payment. This payment, often labeled as “prepaid interest,” compensates the lender for the period before the borrower starts making regular payments. Knowing how per diem interest works, and how to calculate it, can help buyers be better prepared financially.
Calculating per diem interest is straightforward and requires only two key pieces of information: the interest rate of your mortgage and the total loan amount. The formula involves multiplying the loan amount by the interest rate, and then dividing that number by 365—this yields a daily interest charge. For example, if a borrower closes on a mortgage for $350,000 at a 6% interest rate, their annual interest would be $21,000. Dividing this amount by 365 days gives a daily interest of approximately $57.53. If the closing occurs on November 10, and the borrower’s first payment is not due until January, the per diem interest would be calculated for the 20 days between these dates, resulting in an additional cost of $1,150.60 at closing.
Buyers can strategically reduce their per diem interest charges by timing their closing dates or negotiating with sellers. Closing late in the month is often beneficial, as lenders typically begin the repayment period on the first day of the next month. Hence, maintaining a shorter period between closing and the first payment can minimize these costs. Homebuyers should consider discussing possible end-of-month closing dates with their agent, knowing that seller flexibility can vary based on their circumstances, such as transition to a new home. Additionally, a lower interest rate can further decrease the amount of per diem interest owed, which can be achieved by improving one’s credit score, opting for a larger down payment, or utilizing a rate buydown strategy.
In some situations, lenders may offer credits to offset per diem interest, particularly if closing is delayed. For instance, if closing was originally set for a later date in the month but gets moved to the beginning of a new month, lenders might agree to cover some or all incurred per diem interest costs. This arrangement allows borrowers to shoulder fewer days of interest expense, which presents a financial advantage. Understanding these considerations can lead to potential savings for homebuyers as they navigate the complexities of closing costs.
While per diem interest can’t be amicably avoided entirely, proactive measures can minimize its financial impact. Homebuyers are encouraged to ask their lenders about potential credits, discuss favorable timing for closing, and explore options for securing better interest rates before finalizing their loans. It’s also essential to differentiate between per diem interest and annual percentage rate (APR), as they refer to different aspects of the loan. While per diem interest accounts for daily interest charges, APR encompasses the total interest and fees over an entire year, providing a broader overview of the loan’s cost.
In conclusion, per diem interest is an important expense that homebuyers should recognize when closing on a mortgage loan. As the market often presents various closing cost items, understanding and calculating per diem interest can empower buyers to make informed decisions, ultimately resulting in significant financial benefits. With careful planning and strategic timing regarding loan closings, prospective homeowners can effectively manage and potentially minimize their obligations, ensuring a smoother transition into homeownership.