Loan Accrual Basis

Imagine you and a neighbor both buy identical houses next door to each other. You both obtain an identical $100,000 home loan at a 7.00% interest rate with a 30-year term. You go to Lender A, and your neighbor goes to Lender B. You both expect to have the exact same financial journey over the next three decades, but a hidden detail in how your interest "accrues" changes everything.

Lender A uses a 365/365 accrual basis (often called Actual/365). Lender B uses a 365/360 accrual basis (often called Actual/360).

Here is how your two stories play out over 30 years.

The Rules of the Game: Your 365/365 Loan

Your lender looks at the calendar perfectly. To find out how much interest you owe each day, they take your 7.00% annual interest rate and divide it by 365 days in a true year. This gives you a clean daily interest rate of 0.019178%.

When a 31-day month like January rolls around, the invisible "taxi meter" in the background ticks for 31 days. In a short month like February, it only ticks for 28 days. Because the daily rate matches the actual length of the year, your math perfectly aligns with the universe. To fully pay off your loan in exactly 30 years (360 months) with no surprises, your required monthly payment is set at $665.52. Over the course of 30 years, you will pay back your $100,000 principal plus $139,586.87 in interest.

The Twist: Your Neighbor’s 365/360 Loan

Next door, your neighbor’s lender does something a bit more old-fashioned—and a lot more profitable for the bank. When Lender B calculates the daily interest rate, they divide the 7.00% annual rate by a commercial banking year of only 360 days.

Because they are dividing by a smaller number, the daily interest rate jumps up to 0.019444%.

Here is the catch: your neighbor doesn't live in a fantasy world with 360 days; they live in the same world as you. Their lender charges them this slightly higher daily rate for all 365 actual days of the calendar year. In essence, your neighbor is paying interest on 5 "phantom days" every single year.

Because interest grows faster every single day, your neighbor's monthly payment must be permanently jacked up to $672.06 just to keep up with the compounding interest. That is an extra $6.54 every single month.

The 30-Year Finale

Fast forward 30 years. Both you and your neighbor throw a party to celebrate making your 360th and final monthly payments. You both officially own your homes free and clear, and both of your loan balances hit exactly $0.00.

However, your neighbor looks at their bank statements and realizes they got a completely different deal:

• The Monthly Hit: Your neighbor had to find an extra $6.54 in their budget every single month for 360 months straight.
• The Lifetime Penalty: Because of those 5 phantom days calculated every year, your neighbor paid a grand total of $141,940.67 in interest.

Even though you borrowed the exact same amount of money, at the exact same advertised percentage rate, for the exact same amount of time, your neighbor paid $2,353.80 more than you simply because of the way their interest accrued.

Do you know if your bank is Lender A or Lender B?  Just imagine the extra interest paid if your house or farmland loan is larger than $100,000.