When may the 365/360 accrual method be used? Does it matter whether a loan is made for a consumer or business purpose? If a business purpose loan is secured by a business owner’s primary residence, can we use the 365/360 accrual method?

The permitted use in Illinois of the 365/360 accrual method for calculating interest rates depends on whether a loan is made for a business or consumer purpose. It generally is permitted for business loans, but we strongly advise against using it for consumer loans. Its use in consumer loans is not the prevailing industry practice and would risk lawsuits claiming that it is an unfair and deceptive practice.

On the other hand, Illinois law permits lenders to use the 365/360 accrual method for loans made to corporations and similar business entities, as well as for most other business-purpose loans. (The Illinois Interest Act was amended in 2010 to clarify this authorization for business loans, except as noted below.) It expressly provides that for loans made to a corporation as well as for loans that otherwise have a business purpose, “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.”

However, this permissive language is limited with regard to business loans secured by a business owner’s personal goods or primary residence. The Interest Act excludes business loans from its authorization for using the 365/360 method when they are secured by an obligor’s “household furniture or other goods used for his personal, family or household purposes.”

The Interest Act also provides that a loan which otherwise qualifies as a “business loan” is not disqualified as such “because of the inclusion, with other security consisting of business assets of any such obligor, of real estate occupied by an individual obligor solely as his residence.” (emphasis added) Based on this language, we would not recommend using the 365/360 accrual method for a business-purpose loan if the only security for the loan is the business owner’s residence. Instead, when using the 365/360 method for a business loan secured by an owner-occupied residence, we recommend also including “other business assets” as collateral for the loan (particularly for home equity loans made for a business purpose).

For additional discussion of this issue, including an in-depth explanation of the 365/360 method and sample disclosure language for commercial notes, please read our 365/360 Interest Rate Legislation article on our compliance website: http://gotoiba.com/articles/365-360-interest-rate-legislation.

For resources related to our guidance, please see:

Illinois Interest Act, 815 ILCS 205/4(5) (“For purposes of items (a) and (c) of subsection (1) of this Section, 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. The provisions of this amendatory Act of the 96th General Assembly are declarative of existing law.”)

Illinois Interest Act, 815 ILCS 205/4(1) (“It is lawful to charge, contract for, and receive any rate or amount of interest or compensation with respect to the following transactions: (a) Any loan made to a corporationany business loan to a business association or copartnership or to a person owning and operating a business as sole proprietor or to any persons owning and operating a business as joint venturers, joint tenants or tenants in common, or to any limited partnership, or to any trustee owning and operating a business or whose beneficiaries own and operate a business, except that any loan which is secured . . . . by his household furniture or other goods used for his personal, family or household purposes shall be deemed not to be a loan within the meaning of this subsection; and provided further that a loan which otherwise qualifies as a business loan within the meaning of this subsection shall not be deemed as not so qualifying because of the inclusion, with other security consisting of business assets of any such obligor, of real estate occupied by an individual obligor solely as his residence. The term ‘business’ shall be deemed to mean a commercial, agricultural or industrial enterprise which is carried on for the purpose of investment or profit, but shall not be deemed to mean the ownership or maintenance of real estate occupied by an individual obligor solely as his residence; . . . “)

Asset Exchange II, LLC v. First Choice Bank, 953 N.E.2d 446, 452 (1st Dist. 2011) (“There is no dispute here that plaintiff [Asset Exchange II, LLC] is a corporation within the meaning of the Illinois Interest Act, and thus the Act does not apply to plaintiff’s loan agreement with the Bank. Even if we were to find that the Interest Act applies to the loan in this case, to the extent that plaintiff contends that the 365/360 method is illegal or improper, section 4(5) of the Interest Act was recently amended to clarify this exact issue.”)