This method calculates interest assuming each month has 30 days, irrespective of the actual number of days in the month. The annual interest rate is applied to a principal amount, and the daily interest rate is derived by dividing the annual rate by 360. Interest accrues based on this daily rate multiplied by the number of days the principal is outstanding. As a simple example, consider a loan of $10,000 with an annual interest rate of 5%. Using this convention, the daily interest rate is 0.05/360. If the loan is outstanding for 90 days, the interest charged would be approximately $125 (10000 (0.05/360) 90).
This convention simplifies interest computation, particularly in manual calculations and legacy systems. Its use provides a standardized and predictable approach to determine interest charges. Historically, financial institutions have employed this method due to its ease of implementation and computational efficiency, offering a pragmatic approach to interest calculation when computational resources were limited. The benefit lies in the ease of calculation and the ability to standardize across various financial products.