The 360-Day Year: Does It Matter to Borrowers?

2 May 2005 "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?" In all probability, that won�t be necessary. Whether one assumes that there are 360 or 365 days in a year only affects the interest a borrower pays when interest is calculated daily. On your 5.375% mortgage, for example, the daily rate is .01493% if 6 is divided by 360, and it is .01473% if 6 is divided by 365. This difference is relevant to the calculation of prepaid or per diem interest, which 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. If you have a standard mortgage, that is the end of it. Interest is calculated monthly, so your annual rate of 5.375% is divided by 12 to get a monthly rate of .4479%. The assumed number of days in the year, and whether or not it is a leap year, has no impact on your monthly interest payments. BUT! There are some so-called "simple interest mortgages" around on which interest is calculated daily throughout the entire life of the loan. (See What Are Simple Interest Mortgages?) 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, it would amount to more than $2,000 over 30 years. Unfortunately, whether or not interest is calculated monthly or daily is not a required disclosure under Truth in Lending. I have heard from several borrowers who were surprised to discover they had simple interest mortgages, but I don�t know that they were deceived about it. The chances that you have one are small, but you can relieve your anxiety by checking the section of the note that explains how interest on your mortgage is calculated. Copyright Jack Guttentag 2005

Jack Guttentag is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Visit the Mortgage Professor's web site for more answers to commonly asked questions.

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