Question:

How to calculate accrued interest with different day count?

Answer:

To calculate accrued interest correctly you will need to know what day count is used within the lending institution.

Calculating Accrued Interest Using Different Day Count

30/360 This is the most widely used day count convention. A year is assumed to have 360 days and every month is supposedly 30 days long. During February interest accrues the same way as in all other months, and on 31st no interest is added.

X/365 is another popular day count convention. Leap years are ignored, but months are of their regular length. Another very similar day count approach takes into account leap years when calculating accrued interest.

Calculating and Paying Accrued Interest

Every mortgage interest accrued daily. When you make your monthly payment, part of your payment is principal, and part of it is accrued interest (the PI part of the PITI payment). If you are more than 15 days late with your payment, you will have to pay additional interest for the days you are behind. With SIMs (simple interest mortgages), if you are even one day late, interest will accrue very quickly and you will have to pay a lot more, compared to a conventional mortgage.

For example, with a regular mortgage, if you make a mortgage payment 14 days later than the due date and it is posted on time, no one may notice. With a SIM, if you are 14 days late, and you pay around $35 accrued interest a day, you will have to pay 14x35=490 on top of your regular monthly payment plus late fees. You should know how your accrued interest is calculated to avoid procrastinating with simple interest mortgages.

Also, accrued interest is referred often as deferred interest when it is added towards the principal, and allows for negative amortization. Some mortgage instruments are specifically developed and offered as Option ARMs and in this case a minimum payment allows the borrower to make payments at a minimum rate, say, 3.5%, for a limited time.

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