What it means
Interest is quoted as an annual rate, yet payments are made for parts of a year, so someone has to define what a part-year means. The convention answers two questions at once: how many days are in this period, and how many days make up a year.
The common conventions are Actual/360, Actual/365, Actual/Actual and 30/360. Actual/360 counts real calendar days but divides by a 360-day year, which quietly increases the interest paid, while 30/360 pretends every month has 30 days and every year has 360, which makes payment schedules perfectly even.
Money markets and most floating-rate loans use Actual/360, corporate bonds traditionally use 30/360, and government bonds tend to use Actual/Actual. The difference matters most on large balances and long periods.
On a facility of tens of millions of dollars, the gap between Actual/360 and 30/360 over a year is roughly 1.4% of the interest bill, which is why credit agreements state the convention explicitly rather than leaving it to a lender's system default. Business readers meet this in three places: the interest schedule of a term loan, the accrued interest owed when buying a bond between coupon dates, and the settlement of interest rate swaps.
In each case a mismatch between what your model assumes and what the counterparty's system uses shows up as a small unexplained variance that finance teams then spend hours reconciling. The practical habit is to confirm the convention before building any interest model rather than afterwards.
It usually appears in the definitions section of a facility agreement as a single line that is easy to skim past.
In practice
Real-world examples
Example 1
A property developer signs a construction facility with an average drawn balance of $8,000,000 at 8%. The internal model assumes 30/360 and forecasts $960,000 of interest over 18 months, but the agreement specifies Actual/360, so the bill arrives at about $974,000. The finance director spends a morning explaining a $14,000 variance that was never a rate change at all.
Example 2
An asset manager buys $500,000 of a corporate bond 60 days into a 180-day coupon period. The coupon is 6% a year on a 30/360 basis, so the accrued interest owed to the seller is $500,000 x 6% x 60 / 360 = $5,000, which is added to the purchase price at settlement.
Example 3
A corporate treasury team settles an interest rate swap where the floating leg uses Actual/360 and the fixed leg uses 30/360. Each quarter the two legs cover slightly different day counts, producing a small net difference that the team first books as a pricing error before realising it is simply the convention mismatch written into the contract.
Think of it
Think of day count conventions like different measuring systems for baking. One recipe might measure flour by weight, while another uses volume. Both work well, but you need to know which rule is being used so your final result turns out correctly.
Formula
Calculation
Interest = Principal x Annual rate x (Days in period / Days in year)
Take a $1,000,000 loan at 5% covering 1 June to 1 September.
Under Actual/360, the real day count is 30 in June, 31 in July and 31 in August, giving 92 days. Interest = $1,000,000 x 5% x 92 / 360 = $12,777.78.
Under 30/360, each month counts as 30 days, giving 90 days. Interest = $1,000,000 x 5% x 90 / 360 = $12,500.00.
Under Actual/365, the 92 real days are divided by a 365-day year. Interest = $1,000,000 x 5% x 92 / 365 = $12,602.74.
Same loan, same rate, same dates: the borrower pays $12,777.78 - $12,500.00 = $277.78 more under Actual/360 than under 30/360, a difference of about 2.2% of the interest bill for that quarter.Case study
Seen in the real world
Brightwater Distribution is a fictional wholesaler used here as an illustrative case. When it refinanced, the new lender offered what looked like the better deal: 6.8% on an Actual/360 basis against the incumbent's 6.85% on 30/360.
The treasurer built a comparison on a $20,000,000 average balance for a full year. The new lender charged $20,000,000 x 6.8% x 365 / 360 = $1,378,889, while the incumbent charged $20,000,000 x 6.85% x 360 / 360 = $1,370,000. The apparently cheaper rate was around $8,900 a year more expensive.
The illustrative point is that a headline rate is only comparable once both quotes sit on the same day-count basis, and that converting quotes to a common convention should be a standard step in any refinancing comparison.
Watch out
Common mistakes
- Assuming Actual/360 and Actual/365 are close enough to ignore, when the 360-day divisor adds roughly 1.4% to every interest payment.
- Comparing loan quotes on headline rate alone without normalising the day-count basis first.
- Hard-coding 30/360 into a spreadsheet template and reusing it for floating-rate facilities that settle on Actual/360.
Questions
People also ask
Which convention should I expect on a bank loan?
Most commercial floating-rate loans and money market instruments use Actual/360, though this varies by market and should always be confirmed in the agreement.
Does the convention change the interest rate itself?
No, the quoted rate stays the same; the convention changes the fraction of a year the rate is applied to, and therefore the cash amount.
Why does 30/360 exist at all?
It was designed to make bond coupon schedules perfectly regular and easy to calculate by hand, and it survives because so many bond markets and systems are built around it.