How do I calculate the cost of an interest only hard money loan?

Question

Typically these loans are for a year or 2 and paid off in a lump sum.

Natalie Kolodij · Answer

Like you said it is often banking standard.

Started back before calculators and computers to calculate out loan payments and it made for easier computations than 365. Breaks into 12 equal 30 day months.

Ann Bellamy · Answer

David Cs answer is correct as far as it goes (I can't tag him because there are 3 David Cs with no photo, so I don't know which is which) but here is more detail.

To more accurately estimate it:

For 100K, take the principal balance X 12% = $12,000

Divide that by 12 to get the monthly interest, or by 360 to get the daily interest, assuming your lender does not have a clause that says there is a minimum amount, or a prepayment penalty.  So a month's interest would be $1000, and a day's interest would be $33.33

This is further complicated if you take construction draws as you complete the project.  In that case, the daily interest is sometimes calculated on the outstanding principal balance (which will increase with every draw).  In addition, some lenders charge interest on the full amount of the loan, even when they are holding the construction funds pending work done.

Jeff S. · Answer

I think the 360 day Banker's Year was actually created by the ancient Romans. Are you guys also doing your calculations by hand?

A bankers year makes a huge difference for amortized loans, which is why the banks still use it, even though I think even they are sophisticated enough to handle a 365 day year at this point. Here, 365/360 = 1.0139, or a 1.39% increase, which does juice up a return on a multi-decade amortized loan.

It's negligible for a 6-month simple interest loan. Note that 12% x (365/360) is only 12.17%. Also,  29% x (365/360) = 29.4% not 30.6%.  You don’t add the percentages.

Strangely, there are many ways to prorate simple interest and I actually had to have a conversation with my attorney about it. February was making me crazy, as were the title companies who seem to have minds of their own when applying per diem rates. Now we just use actual days and life has been much easier.

For full months, which comprise the majority the duration for most loans, we divide the interest rate by 12 and multiply by the principal balance for that month. This makes the banker's year irrelevant. Same as David's example:

Monthly Payment = 12%/12 months in a year x $100000 = $1000/month

I suppose you could also multiply by 365/360 to take advantage, or claim you don't know any other way to do it, but we don't. I don't want any borrower asking why we agreed to X% and are now charging even a few tenths of a percent more. The first and last months are trickier and there are many ways to prorate the daily interest.

We prorate the monthly payment calculation for the first and last month. Using David's example, assuming we got paid back on Oct 14th, the interest for that month would be:

Interest Payment = 12%/12 months x $100000 x (14/31) = $451.61 or $14.57/day

If this were for funding on Oct 14th (18 days, inclusive of funding day) the interest would be

12%/12 x $10000 x (18/31) = $580.65 or $18.73/day

For a 30-day month, we'd divide by 30 instead of 31.

This is super easy to program into a spreadsheet. If you then want to multiply by 365/360 for the first or last month, that extra amount will literally add only a few dollars. Considering what our borrower probably paid in total points and interest (typically in the tens of thousands for a multi-hundred thousand dollar loan over 6 months), I'm not going to piss them off by asking for an additional $15 at the back end of a loan. It's only a few hundredths of a percent of the total, not 1.39%. This adds no value for the borrower. You might disagree, but I consider this the same as a junk fee.

Also, since we never know the exact payoff date, we specify a daily rate to title. My experience is they will always use the actual number of days in the month to pay us back no matter how skilled I word and re-word our payoff demand.

If you always prorate over a 30-day banker's month, as we used to, and payoff is on the 31st, your borrower will be overcharged. What about February 28th or 29th? You will lose money that month with a strict 30-day calculation and/or your spreadsheet will be horrifically complicated – as was ours. Forget all that. We use actual days elapsed, actual days in the month, and a 365 day year. Many fewer headaches and let the borrower keep his $15 for the $25k we might earn. Even over 100 loans, please don't tell me this is a lot of money.

FYI, if you loan in CA and use a banker's year, you must disclose your method of calculating interest in your note and also state that a 360 day year results in a greater interest payment. We specifically state that we use a 365 day year and the actual number of days elapsed.

Ann Bellamy · Answer

I just came back to answer the question and @Jay Hinrichs has done a much better job than I could.  I'm a small local lender, so no where near the volume that Jay does.  For me, it's ease of calculation with 30 day months.

And deal flow is always an issue.  I've never run out of money, but I've definitely been looking for more dealflow to compensate for the early payoffs for sure, David.

Jay Hinrichs · Answer

Account Closed  drag is related to angle of attack.. got to attack these notes  LOL

Jay Hinrichs · Answer

Account Closed  deal flow is always an issue.. fortunately its not for me.. I get a payoff and sometimes fund right back out same day.. or next day..but we are as you stated high volume shop

not uncommon to have 10 payoffs and new fundings per week..

Drag on the money is very real..

I look at drag very simply I look at a funding bucket and that bucket has its own checking account I look at average daily balance on a monthly basis. one of my buckets has 6 million in it and the average daily balance is usually under 200k through the year.. I see that as highly efficient.. whether I am correct or not.. I don't really know but it feels right to me.. LOL..  As HML goes we are a small shop that carved a niche in a very particular sector of the market that I identified as under served so we stepped right in.

for many investors though a nice 9% note for say 5 years that has 60 on time payments .. those will out perform the 12% short term because of the lack of drag.. we do a million a month of that paper.

Jay Hinrichs · Answer

Account Closed  we do it because it increases our yield... and looks good on the books.

and we don't get caught in a leap year

Chris Mason · Answer

Even when they had early mechanical computers, doing 360 day years meant you could do 12 months times 30 days. And for 30 year mortgages, 12 months times 30 years. 360 payment periods either way. So you wouldn't have to shuffle punch cards around and whatnot, you could just leave the number 360 hard-coded calculating 30 year loans, or calculating pro-rated interest.

Jay Hinrichs · Answer

Account Closed  I have a program that does it automatically as my success to my investor based is ALL based on ROI.. nothing else matters.. and it really satisfies the number crunchers when you can put in your P and L on a project that you made  31.56 % apr.... they love that stuff .

instead of say Hey I think we made about 30%....  as you know early payoffs drive APr's through the roof and I am only as good as my performance.

I had one pay off in 8 days last week.. return was in the 300% range.. or something like that..

Jay Hinrichs · Answer

Account Closed  for me it makes a 29% apr jump to 30.6%  that's huge for me on my deals and for reporting purposes

How do I calculate the cost of an interest only hard money loan?

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