What it means
"Per diem" is Latin for "by the day". When a mortgage is closed in the middle of a month, for example, the borrower owes interest from the closing date to the end of that month, and the daily amount is the per diem.
It is also used when a borrower repays a loan early, because the lender must add interest for the days since the last payment. The calculation takes the annual interest and divides it by the number of days in the year.
Lenders choose between a 365-day year (actual days) and a 360-day year (a banking convention that assumes twelve 30-day months), and the choice matters. The 360-day convention produces a slightly higher daily figure and therefore a slightly higher cost to the borrower over a year.
For businesses, per diem interest appears in invoices, bridging loans, trade finance and payoff letters. A payoff letter lists the balance, the interest accrued to date and the per diem, so that if the payment arrives a few days late the borrower knows how much extra to send.
Finance teams use the same idea to accrue interest expense in their books at each month-end. Per diem interest is simple interest, meaning it is calculated on the outstanding principal without compounding within the period.
It is only the daily share of the annual rate and does not include fees. A borrower comparing offers should ask which day-count convention applies as well as the rate.
A final nuance is that leap years can change the divisor from 365 to 366 under actual-day conventions. Loan documents specify the rule, and the specific wording should be checked before relying on an estimate.
In practice
Real-world examples.
Example
A homebuyer closes on a house on the 20th of the month. The lender charges per diem interest for the 11 days remaining in the month, which the buyer pays at closing, and the first full payment starts the following month.
Example
A manufacturing company repays a $500,000 equipment loan three weeks early. The bank's payoff letter adds per diem interest for the days since the last instalment, so the treasurer sends the exact amount rather than the old balance.
Example
A property investor receives a short-term loan to bridge between buying a building and selling another. The investor models the cost using the daily figure so that delays in the sale can be priced in advance.
Formula
Calculation
Per diem interest = principal x annual interest rate / days in the year
Suppose a business owes a bridging loan balance of $146,000 at an annual rate of 5% on a 365-day basis. Annual interest is 146,000 x 0.05 = $7,300. The per diem is 7,300 / 365 = $20 a day. If the loan is repaid 18 days after the last payment, the interest owed is 20 x 18 = $360. On a 360-day basis the daily figure would be 7,300 / 360 = about $20.28, so 18 days would cost about $365.Case study
Seen in the real world.
Oakline Trading is an illustrative, fictional importer that borrowed $730,000 on a 90-day trade finance facility at 6% a year. The facility used a 365-day year for interest.
The daily interest was 730,000 x 0.06 / 365 = 43,800 / 365 = $120. The shipment cleared customs ten days late, so the company needed to pay an extra 10 x 120 = $1,200 in interest, which the finance manager added to the forecast.
Because the manager knew the per diem in advance, she could see that a short delay was a modest cost and decided to pay a premium for faster clearance only on the larger shipments. The illustrative lesson is that a daily interest figure turns a vague delay into a number the business can plan around.
Watch out
Common mistakes.
- Using the old balance in a payoff without adding the per diem for the days since the last payment, which leaves the loan slightly unpaid.
- Assuming every lender uses a 365-day year, when some use 360 days and charge slightly more for the same rate.
- Treating per diem interest as the whole cost of borrowing, when fees and other charges may apply on top.
Questions
People also ask.
How do you calculate the payoff amount on a loan?
Add the outstanding principal to the interest accrued since the last payment, which is the per diem multiplied by the number of days, and include any fees listed in the payoff letter.
Why do mortgage closings include per diem interest?
Closing dates fall at different points in the month, so the lender charges interest for the days from closing to the end of the month and starts regular payments afterwards.
Does per diem interest compound?
Within a short period it normally does not, because it is calculated on the principal outstanding, although the loan agreement may add interest to principal on set dates.
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