One of the expenses you may have to pay when you purchase or refinance a home is per diem interest.
This daily interest charge appears on line 901 of your HUD-1 form as an “Item Required by Lender to be Paid in Advance.”
This line item breaks down the amount of interest you pay each day on the money you’re borrowing to buy or refinance your home.
You’ll pay daily interest charges for each day from your closing date through the end of the month. Then, you won’t make your first regular mortgage payment until one month later.
For example, if you close on November 15, you’ll pay interest for every day from Nov. 15 through Nov. 30, and you’ll make your first principal and interest payment on Jan. 1—not Dec. 1.
To understand this procedure, you need to understand how paying a mortgage differs from paying rent.
When you rent housing, you pay in advance.
Your December check covers your housing from Dec. 1 through Dec. 31.
However, when you have a mortgage, you pay in arrears. Your January check covers your housing from Dec. 1 through Dec. 31.
When you purchase a home and close on Nov. 15, instead of paying for 16 days of interest on Dec. 1, you pay it at closing. You then pay nothing for December.
Since you won’t make your first full mortgage payment until January, some lenders will say you’re skipping a payment, especially when they’re trying to sell you on a refinance.
That’s not true.
You aren’t skipping a payment or getting anything for free — it just appears that way because mortgage payments are structured differently from rent payments. No matter what day of the month you close on, the lender isn’t giving you any free housing.
Lenders calculate per diem interest by multiplying the amount you’re borrowing by your interest rate, dividing that number by 365, then multiplying the result by the number of days from your closing to the end of the month.
If you’re borrowing $100,000 at 5%, your annual interest is $5,000, and your daily interest is $5,000/365, or $13.70. Nov. 15 through Nov. 30 is 16 days, so your daily interest charge on this loan would be $219.20 ($13.70 times16).
If you close on the first day of the month, you won’t pay any per diem interest since your first mortgage payment will cover the entire month.
This means that if you close on Feb. 1, your March 1 mortgage payment will cover the entire time you’ve had your loan – March 1 through March 31.
When you’re purchasing a home, it doesn’t really matter what day you close because you’ll pay interest for exactly as many days as you have the loan.
If you’re refinancing, there’s a chance you could end up paying interest for the same day twice, once to your old lender and once to your new lender, because of the bureaucracy associated with paying off the old loan and funding the new one.
Some mortgage experts recommend not closing a refinance on a Friday to minimize the number of days you might pay duplicate interest. Closing on a Friday means you may pay duplicate interest for Friday, Saturday, Sunday and Monday since Saturday and Sunday aren’t business days.
Talk to your loan officer about how you can avoid being charged twice.
Finally, don’t confuse per diem interest with prepaid interest.
The latter is a synonym for points, a fee that you might pay to lower your mortgage interest rate.
Per diem or daily interest charges are, in a sense, “prepaid” in that you’re paying interest in advance for a few days instead of in arrears like you will for the remaining term of your mortgage, but calling this expense “prepaid interest” is incorrect.