We strongly advise against using the 365/360 basis for calculating the annual interest rate on consumer loans. It is not the prevailing industry practice, probably for a variety of reasons, including the fact that doing so could incur substantial litigation risks.

It is true that Section 4(1) of the Interest Act contains general language that states: “It is lawful for a state bank or a branch of an out-of-state bank . . . to receive or to contract to receive and collect interest and charges at any rate or rates agreed upon by the bank or branch and the borrower.” 815 ILCS 205/4. However, consumer loans clearly are subject to the Illinois Consumer Fraud and Deceptive Business Practices Act, and the possibility of claims that the practice is confusing or deceptive in the context of consumer loans increases dramatically under that Act.

In fact, the California Supreme Court reached a very similar conclusion more than a quarter of a century ago. In Chern v. Bank of America, 15 Cal.3d 866 (1976), a consumer brought a class action against the lender for using the 365/360 method, even though the method was explained to her and the Truth-in-Lending Statement provided to her correctly disclosed the “actual” interest rate under the method. While there was no suggestion that the method violated the state’s interest laws, and it did not violate the Truth-in-Lending Act, the court nonetheless found that the method was “likely to mislead and deceive” and could constitute “false and misleading advertising” under the state’s consumer protection laws. The court went on to state: “The fact that it may be ‘customary’ business practice within the banking community to quote interest rates on the basis of a 360-day year does not necessarily establish that the practice is not misleading to the general public with whom defendant deals.”

Business loans are another matter. Charging interest on a 365/360 basis for commercial loans is a common industry practice, and the Interest Act was amended in 2010 to expressly authorize this method by stating that, as to loans to corporations and other business loans, “a rate or amount of interest may be lawfully computed when applying the ratio of the annual interest rate over a year based on 360 days.” 815 ILCS 205/4(5).