The 360-Day Year: Does It Matter to Borrowers?
2 May 2005, Revised October 16, 2006, August 27,
2011
"I'm closing tomorrow on a 30-year fixed-rate mortgage at 5.375% for $161,000.. In looking at the HUD1 closing statement, I found that the prepaid interest was calculated on a 360-day basis. Should they not be using a 365-day year in the calculation? Won’t I be paying thousands of dollars of additional interest?…Shall I rescind this loan?"
The 360 day assumption will affect the prepaid or per diem interest you pay at closing, but that is small change. Whether or not it will affect the interest you pay during the life of the loan depends on how interest is calculated on your loan. Examine the note at closing to see whether the mortgage is one of the types on which the 360-day assumption will result in your paying more interest.
The difference between a 360-day and a 365-day year is relevant to the calculation of prepaid or per diem interest. This is interest for the period between the loan closing date and the first day of the following month. That calculation uses a daily interest rate. If your $161,000 loan closed on February 15, 2005, for example, you would owe 14 days of interest to March 1. (If you had closed on February 15th of 2004, however, you would have paid for 15 days because February had 15 days in 2004.)
This does not involve a lot of money. Using 360 days, the 14 days of interest would amount to $336.52, while using 365 days it comes to $332.01, for a difference of $4.51. This is not a reason to rescind your loan.
The most common mortgage in the US, which I term the standard mortgage, accrues interest monthly using a monthly rate. On your mortgage, the annual rate of 5.375% would be divided by 12 to get a monthly rate of .4479%. This rate is multiplied by the balance at the end of each month to obtain the interest due for the month. The assumed number of days in the year or in any given month, and whether or not it is a leap year, has no impact on your monthly interest payments.
On a simple interest mortgage, interest accrues daily throughout the entire life of the loan. (See What Are Simple Interest Mortgages?) On your 5.375% mortgage, the daily rate is .01493% if 5.375% is divided by 360, and it is .01473% if 5.375% is divided by 365. The interest due for a month with 31 days is larger than for a month with 30 days, and the lender collects another day's interest in a leap year.
On these loans, the difference between using a 360 and a 365-day year in calculating the daily rate is significant because the daily rate is applied every day for the life of the loan. On your loan, the difference in interest accrual would amount to more than $2,000 over 30 years.
I became aware of the monthly accrual mortgage on which the monthly interest due is calculated using a daily rate, only after writing the original version of this article. The daily rate is multiplied by the number of days in the month to find the monthly rate. Interest due for the month thus depends on the number of days in the month.
As with a simple interest mortgage, whether or not you calculate the daily rate using 360 versus 365 days has a significant impact on the interest you pay over the life of the loan. The excess payments would be the same on both types of mortgages if borrowers paid on the due date every month. To the extent that borrowers pay after the due date, however, the overpayments would be larger on the simple interest mortgage.
In short, a mortgage can be monthly accrual/monthly interest, which is the standard; daily accrual/daily interest, called simple interest; or monthly accrual/daily interest. In the case of the latter two, using a 360-day year to calculate the daily rate extracts more interest from the borrower.
Unfortunately, whether or not a mortgage is one or the other is not a required disclosure under Truth in Lending. The only way you can know for sure is to check the section of the note that explains how interest is calculated. Since borrowers generally don't get to see the note until closing, that is too late on a purchase loan. You have a refinance, however, so if your inspection of the note reveals bad news, you can rescind.
"I'm closing tomorrow on a 30-year fixed-rate mortgage at 5.375% for $161,000.. In looking at the HUD1 closing statement, I found that the prepaid interest was calculated on a 360-day basis. Should they not be using a 365-day year in the calculation? Won’t I be paying thousands of dollars of additional interest?…Shall I rescind this loan?"
The 360 day assumption will affect the prepaid or per diem interest you pay at closing, but that is small change. Whether or not it will affect the interest you pay during the life of the loan depends on how interest is calculated on your loan. Examine the note at closing to see whether the mortgage is one of the types on which the 360-day assumption will result in your paying more interest.
Per Diem Interest
The difference between a 360-day and a 365-day year is relevant to the calculation of prepaid or per diem interest. This is interest for the period between the loan closing date and the first day of the following month. That calculation uses a daily interest rate. If your $161,000 loan closed on February 15, 2005, for example, you would owe 14 days of interest to March 1. (If you had closed on February 15th of 2004, however, you would have paid for 15 days because February had 15 days in 2004.)
This does not involve a lot of money. Using 360 days, the 14 days of interest would amount to $336.52, while using 365 days it comes to $332.01, for a difference of $4.51. This is not a reason to rescind your loan.
Interest on a Standard Mortgage
The most common mortgage in the US, which I term the standard mortgage, accrues interest monthly using a monthly rate. On your mortgage, the annual rate of 5.375% would be divided by 12 to get a monthly rate of .4479%. This rate is multiplied by the balance at the end of each month to obtain the interest due for the month. The assumed number of days in the year or in any given month, and whether or not it is a leap year, has no impact on your monthly interest payments.
Simple Interest Mortgages
On a simple interest mortgage, interest accrues daily throughout the entire life of the loan. (See What Are Simple Interest Mortgages?) On your 5.375% mortgage, the daily rate is .01493% if 5.375% is divided by 360, and it is .01473% if 5.375% is divided by 365. The interest due for a month with 31 days is larger than for a month with 30 days, and the lender collects another day's interest in a leap year.
On these loans, the difference between using a 360 and a 365-day year in calculating the daily rate is significant because the daily rate is applied every day for the life of the loan. On your loan, the difference in interest accrual would amount to more than $2,000 over 30 years.
Monthly Accrual Mortgages Using a Daily Rate
I became aware of the monthly accrual mortgage on which the monthly interest due is calculated using a daily rate, only after writing the original version of this article. The daily rate is multiplied by the number of days in the month to find the monthly rate. Interest due for the month thus depends on the number of days in the month.
As with a simple interest mortgage, whether or not you calculate the daily rate using 360 versus 365 days has a significant impact on the interest you pay over the life of the loan. The excess payments would be the same on both types of mortgages if borrowers paid on the due date every month. To the extent that borrowers pay after the due date, however, the overpayments would be larger on the simple interest mortgage.
In short, a mortgage can be monthly accrual/monthly interest, which is the standard; daily accrual/daily interest, called simple interest; or monthly accrual/daily interest. In the case of the latter two, using a 360-day year to calculate the daily rate extracts more interest from the borrower.
Truth in Lending Doesn't Help
Unfortunately, whether or not a mortgage is one or the other is not a required disclosure under Truth in Lending. The only way you can know for sure is to check the section of the note that explains how interest is calculated. Since borrowers generally don't get to see the note until closing, that is too late on a purchase loan. You have a refinance, however, so if your inspection of the note reveals bad news, you can rescind.