Loan proration at closing splits interest between the parties or across billing periods based on the exact number of days you actually owe the money. The math is simple: principal balance × daily interest rate × number of days in the partial period. The daily rate is your annual rate divided by either 360 or 365, depending on what your loan documents specify. That figure shows up as “prepaid interest” on a Closing Disclosure when you take out a mortgage, and as accrued interest on a payoff statement when you close out a loan early or refinance.
When Proration Applies
Three situations trigger it. A mortgage closing that lands after the first of the month, because you owe interest from the funding date through month-end before your regular payment schedule kicks in. An early payoff, because interest has accrued daily since your last payment and the lender has to count those days. A refinance, because the old loan’s interest has to be prorated to the exact date the new loan replaces it so charges don’t overlap.
Auto loans and personal loans work the same way at payoff. Most consumer installment loans use simple interest that accrues daily on the outstanding principal, so paying ahead means the lender calculates a per diem, multiplies by days elapsed since your last payment, and adds that to your remaining balance for the payoff total.
Why Mortgages Collect Interest at Closing
Mortgage interest is paid in arrears. Your payment on the first of each month covers interest that already accrued during the previous month. That leaves a gap at closing: you’ve started borrowing, but your first scheduled payment is weeks away.
Prepaid interest fills the gap. At closing you pay interest from your funding date through the last day of that month, and your first regular payment then arrives on the first of the following month after that, covering the full month in between. If your loan funds on October 17, you prepay interest for October 17 through October 31 at the table, and your first regular payment on December 1 covers November.
The closer to month-end you close, the less prepaid interest you owe. Close on October 28 and you prepay three days. Close on October 3 and you prepay 28. The total interest over the life of the loan barely moves, but the cash you need at closing shifts a lot.
What You Need Before You Calculate
Four inputs drive every proration:
- Outstanding principal balance. Use the current balance your lender quotes as of a specific date, not the original loan amount.
- Annual interest rate. The rate stated in your promissory note, not the APR, which bundles other costs.
- Day-count convention. Lenders use either a 360-day year (each month treated as 30 days) or a 365-day year. Residential mortgages often use 360; many consumer and commercial loans use 365. Your loan documents say which one. A 360-day divisor produces a slightly higher daily rate.
- Days in the partial period. Count from the date interest begins accruing (your funding date, or the day after your last payment) through the closing or payoff date.
One trap on refinances: funding and signing are not the same day. Federal law gives you a three-day right to cancel a refinance, so funds disburse after the rescission period ends. Interest accrues from disbursement, not signature, which can move your proration by several days.
A Worked Example
Take a $200,000 balance at a 6% annual rate. Annual interest is $200,000 × 0.06 = $12,000. Divide by 365 and the daily rate is about $32.88. Twelve days in the partial period comes to $394.52.
Run the same numbers on a 360-day year. Annual interest is still $12,000, but the daily rate is $33.33. Twelve days comes to $400.00. The $5.48 difference looks small, but on larger balances or longer partial periods the gap widens quickly. Confirm the convention before you check the lender’s math.
This assumes simple interest, which is standard for the great majority of consumer loans: interest accrues only on outstanding principal each day, and it isn’t folded back into the balance.
Reading Prepaid Interest on Your Closing Disclosure
Prepaid interest appears on Page 2 of the Closing Disclosure under Section F (“Prepaids”). The line typically states the per diem amount, the number of days covered, and the total charge.1Consumer Financial Protection Bureau. What Are Prepaid Interest Charges That total rolls into your closing costs, either paid at the table or netted out of loan proceeds. Multiply the per diem by the day count and you should get the total exactly; if you don’t, ask which day-count convention was used.
Payoff Statements and the Good-Through Date
To pay off a mortgage or refinance, request a payoff statement in writing. Your lender or servicer must provide it within seven business days.2Office of the Law Revision Counsel. 15 USC 1639g – Requests for Payoff Amounts of Home Loan The statement shows the unpaid principal balance plus accrued interest through a specified date, along with any fees.3Fannie Mae. Multifamily Guide – Calculating the Full Payoff Amount
Every quote carries a good-through date, which may extend up to 30 days from issuance. Miss it and the quote expires, because interest keeps running. You’ll need a new statement with a recalculated figure.
If Your Loan Uses Precomputed Interest
Simple daily interest is the assumption behind everything above. Precomputed loans work differently: the lender calculates all interest upfront and builds it into the payment schedule. Paying early entitles you to a refund of unearned interest, and the refund method matters.
The Rule of 78s heavily front-loaded interest, so early payoff returned much less than a borrower might expect. Federal law now prohibits the Rule of 78s for any precomputed consumer loan with a term longer than 61 months originated after September 30, 1993.4Office of the Law Revision Counsel. 15 USC 1615 – Prohibition on Use of Rule of 78s in Connection With Mortgage Refinancings and Other Consumer Loans For those loans, the actuarial method applies, allocating each payment first to accrued interest and then to principal. Shorter-term precomputed loans may still use the Rule of 78s in some states, so read the loan agreement before you assume a proportional refund.
Federal Tolerances If the Number Looks Wrong
Lenders sometimes get the prorated figure wrong. Regulation Z sets how far off a disclosed finance charge can be before it’s a violation. For mortgages, the disclosed finance charge is considered accurate if it understates the actual amount by no more than $100, or if it overstates it.5eCFR. 12 CFR 1026.18 – Content of Disclosures
Non-mortgage consumer loans have tighter tolerances. If the amount financed is $1,000 or less, the finance charge must be within $5. Above $1,000, the tolerance is $10.5eCFR. 12 CFR 1026.18 – Content of Disclosures Errors outside those ranges are grounds for dispute. Most mistakes come from the wrong day-count convention or a stale principal balance, not arithmetic.
Other Items Prorated at Closing
Interest isn’t the only cost split at the table. Property taxes and homeowner’s insurance premiums are prorated between buyer and seller based on the closing date. If the seller has paid taxes covering days you’ll own the home, you reimburse them at closing; if taxes are due but unpaid, the seller credits you for their share.
Prepaid mortgage interest is generally deductible as home mortgage interest, but interest paid in advance that covers a period past December 31 must be spread across the tax years it actually covers rather than deducted all at once.6Internal Revenue Service. Publication 936, Home Mortgage Interest Deduction For a standard closing where prepaid interest only covers the remaining days of the current month, the full amount is deductible in that year. Your lender reports the properly accrued portion on Form 1098; match your return to what the 1098 shows.