Prepaid Interest (Per-Diem Interest)
Interest charged at closing for the days between funding and the first regular payment, calculated per day. A line item in closing costs that varies with your closing date.
Prepaid interest — also called per-diem (per-day) interest — is the interest charged at closing to cover the days between the day your loan funds and the start of your first full payment period. Because mortgage payments are made in arrears and on a set monthly cycle, there's usually a gap of several days at the start that's collected up front as prepaid interest. It's a routine line item in closing costs that catches investors off guard mainly because it varies with the closing date.
Why it exists
Loan payments typically cover the prior period and are due on the 1st of the month. But your loan funds on whatever day you close — rarely the 1st. Prepaid interest bridges that mismatch by charging interest for the partial period from funding to the first regular cycle, so everything aligns to the normal monthly schedule going forward.
How it's calculated
It's a simple daily rate times the number of days:
Per-Diem = (Loan Amount × Annual Rate) ÷ 365
Prepaid Interest = Per-Diem × Days from funding to cycle start
Example: a $200,000 loan at 7.25%:
Per-diem = (200,000 × 0.0725) ÷ 365 ≈ $39.73/day
Close with 12 days remaining → 12 × $39.73 ≈ $477 prepaid interest
The closing-date lever
The number of days — and thus the cost — depends on when in the month you close:
- Close early in the month → many days of prepaid interest collected → higher charge at closing.
- Close late in the month → few days → lower charge.
This is why some borrowers schedule closings toward month-end to minimize prepaid interest at the table (though it's a cash-flow timing choice, not real savings — you pay interest for the days you hold the loan either way).
Prepaid interest in the bigger picture
Prepaid interest is one of several prepaids collected at closing, alongside the first year of insurance and any initial escrow/tax deposit. Together these are part of your total closing costs and cash-to-close. On short-term hard money loans, interest mechanics differ (often interest-only from day one, sometimes with an interest reserve), so per-diem prepaid interest is more a feature of amortizing DSCR and conventional-style loans.
Practical takeaway
Don't be surprised by prepaid interest on your closing statement — it's normal and simply front-loads the interest for the stub period before your first regular payment. If minimizing cash at the table matters, ask your lender how closing date affects it and consider a later-in-month closing. But focus your real comparison on the loan's rate, points, and total cost over your hold — prepaid interest is a small, date-driven timing item, not a meaningful difference between loan offers.
Frequently asked questions
What is prepaid interest at closing?
Interest collected at closing to cover the days between when your loan funds and the start of your first regular payment period. Because payments follow a set monthly cycle but loans fund on whatever day you close, prepaid (per-diem) interest bridges that partial period so payments align to the normal schedule afterward.
How can I reduce prepaid interest?
Close later in the month. The charge is the daily interest times the number of days from funding to the cycle start, so closing near month-end means fewer days and a smaller charge at the table. Note it's a cash-flow timing choice, not true savings — you pay interest for the days you actually hold the loan regardless.
Do hard money loans have prepaid interest?
Less so in the per-diem sense. Hard money loans are often interest-only from day one, sometimes with an interest reserve built into the loan, so the prepaid per-diem mechanic is more a feature of amortizing DSCR and conventional-style loans. Confirm how your specific loan handles the first period's interest.