Playing Fair With Interest Rates

by Anne Paddock

Most people are interest rate sensitive and don’t want to pay more than they have to when borrowing money. No one knows this more than a banker and bankers being the creative profit mongers they are (I should know; I used to be one of them) have a way of making more money on a loan without most people realizing it. The profit is in the details and most people don’t pay attention to the details. Instead, they focus on the interest rate when in fact they should also focus on two things:

The interest rate
If the interest is calculated on a 360 or 365 day basis

Certainly the interest rate is of primary importance but whether the interest is calculated based on a 360 or a 365 day year is also important. The difference may seem insignificant as there appears to be little difference between 360 and 365 days, but there is a difference. To illustrate, a $500,000 loan at 5% based on a 360 and 365 day year is calculated as follows:

5% / 360 = .0001389 (equals the daily rate) x 500,000 = $69.44

5% / 365 = .0001370 (equals the daily rate) x 500,000 = $68.49

As illustrated above, the difference is approximately .95 cents per day or $346.75 annually based on an outstanding balance of $500,000. Most principal balances decrease so the amount of interest that accrues will go down over time but the point is this: the bank is extracting more interest from a consumer that is paying 5% interest based on a 360 day year than a consumer paying 5% interest based on a 365 day year.

How interest is calculated has a significant impact on the amount of interest you will pay over the life of the loan. Read the note and pay particular attention to the section of the note that explains how interest is calculated. Insist the interest be calculated based on a 365 day year because there are 365 days in a year (except for the leap year which works to the banks advantage because interest is calculated based on a 365 day year when in fact there are 366 days in a leap year), not 360 days. Any banker will have a hard time arguing against your logic.

Know that loan parameters are automated and all banks have fields in their systems to specify how the interest is to be calculated because not all loans are calculated the same. So, if the banker tells you a 360 day basis is in the system, insist otherwise. All bank loan administration departments have the ability to put in multiple ways to calculate interest because bank software allows this input. Don’t be afraid to stand up and insist the bank do the right thing.