Actual 365

Definition of Actual/365

The Actual/365 day count convention is a financial calculation method used to determine the amount of interest accrued on a loan over a specific period. In this method, the actual number of days in the interest period is used as the numerator, and a fixed 365 days is used as the denominator (the year). This convention is frequently found in commercial mortgage contracts, personal loans, and certain types of government bonds.

Detailed Description

In commercial real estate finance, the day count convention dictates how a lender calculates the "per diem" or daily interest rate. While the stated annual interest rate remains the same, the convention used can change the actual dollar amount the borrower pays. The Actual/365 method provides a transparent and precise reflection of the calendar year.

The core components of the Actual/365 method include:

• The Numerator: The calculation counts the exact number of days that have elapsed. For example, a payment for the month of January would calculate interest for 31 days, while April would calculate for 30 days.
• The Denominator: Regardless of whether the year is a leap year, the annual interest rate is divided by 365 to establish the daily interest charge.
• Effective Interest Rate: Because the denominator matches the standard number of days in a year, the effective interest rate paid by the borrower is equal to the nominal or "stated" interest rate in the loan documents.

Actual/365 vs. Other Conventions

To understand the impact of Actual/365 on a commercial mortgage, it is helpful to compare it to other common industry standards:

• Actual/360: This is the most common convention in commercial lending. Because the year is divided by 360 instead of 365, the daily interest charge is slightly higher. Over the course of a year, an Actual/360 loan results in about 5 to 6 extra days of interest compared to Actual/365.
• 30/360: This method assumes every month has exactly 30 days and the year has 360 days. While this makes monthly payments consistent, it does not account for the actual number of days in the calendar.
• Actual/Actual: This method uses the actual number of days in the month and the actual number of days in the year (365 or 366). This is the most mathematically precise but can be more complex to calculate during leap years.

Importance for Commercial Borrowers

For a commercial borrower, the Actual/365 convention is generally more favorable than the Actual/360 convention. On a large balance commercial mortgage, the difference of five days of interest per year can amount to thousands of dollars in savings over the life of the loan. When comparing term sheets from different lenders, it is critical to look beyond the stated interest rate and identify which day count convention is being applied, as an Actual/365 loan at 5.00% is less expensive than an Actual/360 loan at the same rate.