When doing a real estate closing or figuring an interest payment due a lender, the amount of days since the original purchase to the date payable can be calculated only if you know the number of days in between. Because there are different numbers of days in different months and an occasional leap year, it can be easy to miscalculate the numbers of days. It's important that a borrower know how to calculate a payoff so the lender, especially hard money lenders, do not over charge you.
In the financial arena, Treasury bonds use a 365 day year while almost all other interest-bearing bonds and notes have an arbitrary 360 day year. The reason is simple - to make it easier for lenders to calculate the accrued interest on bonds. However, the US Treasury sells trillions of dollars of bills, notes and bonds and a few days interest can mean billions of dollars in no time.
In this exercise we will look at how to calculate the amount of interest due when you borrow or lend for a specific time period. For this example we will use a deal I closed recently.
I loaned $50,000 for a property on February 26, and it sold and closed on April 3. The interest rate was 10% and it had a pre-payment penalty of $834 if it was closed before May 26. Here is an example of a no-money deal for this Student because I privately funded it.
Typically, private money borrowing is very simple. You get a mortgage, Quitclaim Deed or deed of trust in exchange for the money you loan the buyer of the property. Typically, a borrower would pay a much lower interest rate on private money instead of hard money.
Private money comes from casual lenders who opt to loan to investors instead of getting low interest rates on their savings accounts or Certificates of Deposits (CDs). The interest rates they charge are mostly dictated by the borrower (investor) and should be well below "commercial" or hard money rates.
Hard money comes from lenders who charge points to close, junk fees, high interest rates and require strict loan requirements. Private lenders might get 5% on a specific loan with no closing points while a hard money lender giving the same loan will get 3 points (3%) to close, $750 in fees and 15% until the loan is paid off.
Just before any closing, the closing agent will send the lender a "payoff letter". It may come in the form of a Payoff Authorization Letter for the borrower to sign. The bottom line is that the lender must stipulate to the closing agent how much is owed in principal, interest and any other charges due at closing. If the deal doesn't close on that date, the closing agent will need a "per diem" which is a daily interest charge.
For the above example here is the more complicated way of arriving at the payoff amount that is used by most lenders:
1. You calculate the number of days between 2/26 and 4/3. I did this online at http://www.timeanddate.com/date/duration.html
Hint - you should count the day of closing day as one of the days in the calculation if you are charging interest.
The result for the above example shows that I had loaned the money for 37 days to the investor Student).
2. I then did a calculation to determine the amount of interest I would earn for the entire year => $50,000 x 10% = $5,000.
3. Next I divided the $5,000 interest for the year by 365 days to determine the "per-diem" or daily amount accrued from the property owner. This looked like $5,000/365 = $13.69863 or I called it $13.70 per day.
If the amount owed was in the millions, the actual last 4 or 5 digits would be used in the calculation to determine the accrued interest but a round off to $13.70 is fine for these calculations.
4. Finally, I multiplied the number of days the money was on loan (37) times the daily interest charge = 37 x $13.70 = $506.85.
5. The pre-payment penalty was $834 so there is no calculation needed for this amount.
6. Total income on the loan for 37 days was $506.85 + $834 = $1,340.85.
In summary, 10% on an investor loan may not sound very good if you are getting hard money rates. I have seen some hard money lenders charge as little as 8% interest on their loans to well-qualified borrowers. However, the more expensive cost is the prepayment penalties, points, junk fees (property inspection, etc.) and document prep charges.
In summary, it is important that you understand how to calculate accrued interest because you will be paying it or receiving it in the future. Double check the closing agent's calculations prior to closing and you may be surprised that mistakes do happen even with people who do this repeatedly.
If the amount of interest and pre-payment penalty you at looking at paying seem expensive, first shop around more. But always remember that if you lose the deal because you didn't have money to close, you will make no money at all. In this case the Student made over $30,000 on the transaction.
The simple way to get this calculation done quickly, accurately and efficiently is with my "Loan Payoff Calculator" located on my website at http://www.TransactionalFundingFL.com
There is no cost or obligation to get it and it will save you tons of money the more often you borrow. I don't' even ask for your email address to get it!
To your limitless success!
About the Author:
Dave Dinkel has over 40 years experience in Real Estate Investing which has given him a unique perspective into the Market. Learn the proven methods of today's successful Real Estate Investors. Visit Dave Dinkel's site to get you started as a Real Estate Investor today! Click the link Now http://www.davedinkel.com