30/360

Understanding the 30/360 Day Count Convention

In the world of commercial real estate finance, the 30/360 day count convention is a standardized method used to calculate the amount of accrued interest on a mortgage or loan. Unlike methods that use the actual number of days in a calendar month, the 30/360 method is based on the simplified assumption that every month contains 30 days and every year contains 360 days.

Detailed Description of the 30/360 Method

The 30/360 convention is designed to provide consistency and predictability for both lenders and borrowers. Because every month is treated as having the same duration, the interest payment remains identical every month, regardless of whether the actual month has 28, 29, 31, or 30 days. This makes it a preferred method for fixed-rate commercial mortgages where level debt service is required.

How the Calculation Works:

To calculate the interest for a specific period using the 30/360 method, the following formula is typically applied:

Interest = (Principal Balance × Annual Interest Rate) / 360 × 30

There are specific rules applied to handle the discrepancies between the calendar and this simplified model:

• The 31st Day: If a month has 31 days, the 31st day is ignored for interest calculation purposes. The borrower is only charged for 30 days.
• February: Even though February has only 28 or 29 days, it is treated as having a full 30 days. This means the borrower pays for 30 days of interest during the shortest month of the year.
• Standardization: Because the denominator is always 360, the daily interest rate is slightly higher than it would be in an Actual/365 convention, but the "missing" 5 or 6 days of the year usually balance the cost for the borrower.

Why It Is Used in Commercial Mortgages

The 30/360 convention is a legacy of the era before modern computing, as it allowed accountants to calculate interest by hand or with simple ledgers without tracking the specific number of days in each month. Today, it remains a standard in the Commercial Mortgage-Backed Securities (CMBS) market and for many private commercial loans for several reasons:

• Payment Consistency: It ensures that the monthly interest payment is exactly 1/12th of the annual interest amount, making budgeting and financial modeling more straightforward.
• Secondary Market Standards: Many institutional investors and bondholders prefer 30/360 because it simplifies the valuation of cash flows over long durations.
• Administrative Ease: It eliminates variations in monthly billing that would otherwise occur due to the "leap year" effect or the varying lengths of months.

While 30/360 is common, it is important for borrowers to distinguish it from the Actual/360 convention. In an Actual/360 calculation, the lender uses the actual number of days in a month (up to 366 in a leap year) but still divides by 360. This results in a higher effective interest rate than the 30/360 method, as the borrower pays for 365 or 366 days of interest over a 360-day denominator.