Commercial real estate lenders calculate interest on loans in three ways:

1. 30/360

2. Actual/365 (aka 365/365)

3. Actual/360 (aka 365/360)

Real estate underwriters should be aware of these 3 methods and understand which calculation the lender is using.

The differences can have a significant impact on the amount of interest paid over the life of the loan. Similarly, it can also have an impact on the amount of cash flow that is available to be distributed to your investors.

To confirm which interest rate calculation the lender will be using, look in the loan agreement, as shown below:

In simple terms, let’s break down how to calculate interest 3 different ways:

30/360

With the 30/360 interest accrual method, it is assumed that there are 30 days in every month and 360 days in the year.

1. First, the annual interest rate is divided by 360 to get the daily rate. 5.00% divided by 360 days equals .013889%.

2. Daily accrual rate is multiplied by 30 days in the month to get .041667%. This is the monthly accrual rate.

3. Finally, the monthly accrual rate is multiplied by the loan balance of $1,000,000. The result is $4,166. This is the interest of the first loan payment.

Actual/365

With Actual/365, interest is accrued based on the actual number of days in the month and the assumption that there are 365 days in the year.

1. Annual interest rate is divided by 365 days to get the daily accrual rate. The 5% divided by 365 days equals .013699%.

2. Second, the daily accrual rate is multiplied by the actual number of days in the month. Assume that the first payment occurs in January, which has 31 days. So, .013699 * 31 is equal to .042%.

3. Finally, the loan of $1,000,000 is multiplied by .042% to get the monthly interest payment of $4,246 for the first month’s payment

Actual/360

With Actual/360, interest is accrued based on the actual number of days in the month and the assumption of 360 days in a year. The calculation follows the same three steps.

1. First, the annual interest rate is divided by 365 days to get the daily accrual rate. The 5% divided by 365 days equals .013699%.

2. Second, the daily accrual rate is multiplied by the actual number of days in the month. For this example, assume that the first payment occurs in January, which has 31 days. So, .013699 * 31 is equal to .0424658%.

3. Finally, this number is calculated by the outstanding balance of $1,000,000 to get the monthly interest payment of $4,246 for the first month’s payment.

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