What Is Interim Interest?
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Why Do Lenders Charge Interim Interest?
Interim interest is the interest charged on a loan or credit line that accrues between the disbursement date and the date on which the first regular interest payment is due. It is typically a short-term loan used to bridge the gap between the disbursement of a long-term loan and the first payment due date. This interest is usually charged at a higher rate than the regular interest rate.
Lenders charge interim interest when the closing date for a mortgage does not fit into a regular monthly time frame (such as when the closing date for a mortgage falls in the middle of the month). In this case, the lender may charge interest accrued on these days based on the annual interest rate.
Interim interest also comes into play with construction projects that require a prolonged period after the loan closing but before the construction is complete. During this time, the borrower will make interest-only payments until construction is finished, when their regular amortizing payments begin. The interest-only payments made during this period are also known as “interim interest.”
Generally, mortgage interest is paid after the fact (i.e., postpaid) because a lender can collect it only when it builds up for the whole month. Lenders often set the due date on the first of every month to make it easy for everyone involved.
Therefore, if a borrower closes in the middle of May, the first monthly mortgage payment will not be due until at least July 1 (or even until July 15 when the grace period is accounted for). The borrower does not have to pay anything in June yet since only partial interest has accumulated in May.
Some borrowers might think they are skipping a mortgage payment because of this. However, it only defers the first payment on loans.
Interim Interest vs. Regular Interest
Interim interest differs from the interest included in regular or monthly mortgage payments.
Technically, interim interest is a closing cost. It can increase the borrower’s total amount to pay out of pocket, which is why it is important to close strategically. In the example above, if the borrower closed on May 26 instead of May 16, they would have ten fewer days accrued, making their interim interest lower.
In addition, interim interest is paid without a principal component. Therefore, not only is the borrower’s debt not paid when paying interim interest, but it also does not create equity.
How Is Interim Interest Calculated?
The formula to calculate interest is per diem interest times the number of days in the mortgage interim period.
It may be helpful to understand these two variables first.
- Mortgage Interim Period – The interim period refers to the time between when one closes on a mortgage to the end of the same month. For example, if a borrower closes on May 16, then the interim mortgage period will be from May 17 to May 31, a period of 15 days.
- Per Diem Interest – Per diem is Latin for “per day.” It describes how much interest a lender charges per day on a mortgage.
Calculating Interim Interest
Consider a mortgage of $300,000 with an annual rate of 4.5%. To calculate the interim interest, follow the steps below:
- Convert the interest to decimal (e.g., 4.5% divided by 100 = 0.045).
- Divide the decimal-converted interest by 365 to find per diem interest (e.g., 0.045 divided by 365 = 0.00012328767).
- Multiply this number by the mortgage amount (e.g., 0.00012328767 times 300,000 = 36.986301, rounded off to $36.99, which is the per diem interest or interest charged daily).
- Finally, multiply this per diem interest with the number of days in the interim period (e.g., 36.99 x 15 days, in the example above = 554.85).
The interim interest is $554.85.
Is There a Way to Avoid Paying Interim Interest?
Interim interest has to be paid one way or another, usually by the borrower.
However, in certain circumstances, the borrower can pass the burden on to a cosigner or even the lender or seller. The borrower may also convert it into a postpaid expense.
There are several ways to do so.
Rolling Closing Costs Into the Mortgage
Borrowers can roll the closing costs into the mortgage balance to reduce the amount they have to pay upfront. That said, the borrower will pay more interest in the long run since the principal amount has become bigger due to the addition of closing costs.
Using a Lender Credit
Another way to avoid paying interim interest is to use a lender credit, which lets the borrower avoid paying closing costs upfront. This is not free money, of course. In exchange for covering such fees on behalf of the borrower, the lender will usually want a higher interest rate. Some lenders are willing to negotiate this rate increase.
Negotiating a Seller Concession
Finally, a borrower may take advantage of a seller concession.
In a buyer’s market, some sellers may agree to take care of the other party’s closing costs. The usual string attached to concessions is a higher purchase price, which means the buyer will have to borrow more money.
However, seller concessions are harder to come by in warmer markets since sellers can afford to be selective. First, the appraisal should be able to justify the higher purchase price. Secondly, more sale proceeds can mean greater commissions. Therefore, a buyer who asks for a concession in such a market is less attractive to sellers.
BY THE NUMBERS: Closing costs account for 3% to 6% of a property’s price.
Source: Rocket Mortgage
- Interim interest is a prepaid mortgage expense charged from the date of closing to the first monthly payment, which is usually the first day of the following month.
- To calculate interim interest, multiply the interest the lender charges per day by the number of days in the mortgage interim period.
- Interim interest is charged to the borrower, but the lender or seller can assume responsibility for it in exchange for higher interest rates or purchase prices, respectively.
- All forms of prepaid mortgage interest must be paid upfront, except when they are rolled into the loan balance and other closing costs.
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