Borrower feels deceived by mortgage interest calculation
Does a mortgage year have only 360 days?

Monday, May 23, 2021

By Jack Guttentag
Inman News

"I'm closing tomorrow on a 30-year fixed-rate mortgage at 5.375 percent 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 percent mortgage, for example, the daily rate is .01493 percent if 5.375 is divided by 360, and.01473 percent if 5.375 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 Feb. 15, 2005, for example, you would owe 14 days of interest to March 1. (If you had closed on Feb. 15, 2004, however, you would have paid for 15 days because February had 29 days in 2004.)

This does not involve a lot of money. Using 360 days, the 14 days of interest would amount to $336.53, while using 365 days it comes to $332.01, for a difference of $4.52. 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 percent is divided by 12 to get a monthly rate of .4479 percent. 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" on which interest is calculated daily throughout the entire life of the loan. 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 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.

Any Advantage in 52 Payments a Year?

"I have been following your advice by increasing my monthly payment by one-twelfth. My lender has suggested that I instead switch to a weekly payment plan, for which they charge $1 per payment. Would this plan result in my paying off my loan sooner?"

No, because weekly payment plans do not involve any additional payments. Your monthly payment is multiplied by 12 and divided by 52 to get the weekly payment, so you make the equivalent of 12 monthly payments a year. When you increase the monthly payment by 1/12, you make the equivalent of 13 payments a year.

You can make the two schemes comparable by increasing the weekly payment by one-twelfth as well. Then you would make the equivalent of one extra monthly payment a year in both schemes. If you did that, you would pay off a little sooner using the weekly payment scheme, provided the weekly payments are applied weekly – meaning that the balance is reduced every week. Ask the lender whether weekly payments are applied weekly, or whether they are held until month-end.

"I was told that the weekly payments are held in a special account, and on the first of every month a withdrawal is applied to the mortgage payment."

That means that there is no interest savings to you in making weekly payments. And since the $1 payment fee is added to the balance, your loan will pay off less quickly under the weekly payment plan than under the monthly payment plan you are using now. The only possible benefit is the budgetary discipline that might be valued by borrowers who pay weekly.

The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.

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Copyright 2005 Jack Guttentag


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