Accrued Interest

What Is Accrued Interest? 

Accrued interest is the amount of unpaid interest that has accumulated as of a specific date, either on a loan or credit card you’re repaying or on an interest-bearing account or investment.  
 
Accrued interest can be owed or earned. For example, with a loan or credit card, it’s the amount of interest (payment you owe) that has been incurred since you made your last payment. With an interest-bearing account or an investment, such as a bond, it's the interest (income you earned) that has accumulated since the last time you received a payment from the financial institution or bond issuer.

How Does Accrued Interest Work? 

The way accrued interest works depends on several factors, including the type of account, the balance or principal, the interest rate, timing, and whether you are borrowing money (such as with credit cards, auto loans, and personal loans), or earning money (such as with interest-bearing checking or savings accounts).  

Accrued Interest on Loans 

Personal loans, auto loans, and other types of debt charge interest to their borrowers. Most lenders use the simple interest method of accounting, which means that interest that accrues each day is based only on the principal balance of the loan and doesn't compound on previously accrued interest. 

For example, on a personal loan, the interest on your debt accumulates daily based on your current loan balance and interest rate. When you make a loan payment, a portion of your total payment amount goes toward the interest that has accrued since your last payment and the remainder goes toward paying down the principal balance of your loan. 

If you have a fixed interest rate, the daily interest amount will go down over time as your principal amount owed decreases with on time payments. With variable rate loans, the amount of interest that accumulates can fluctuate along with the loan's interest rate, however there's generally a downward trend with timely payments.  

Accrued Interest on Bank Accounts 

Generally, with interest-bearing deposit accounts, such as a high-yield checking or savings account, interest typically accumulates daily and is paid out monthly. The amount of interest that accrues is based on your balance and the account's annual percentage yield or APY (which may adjust higher or lower as rates rise or fall) and compounding interest. The higher the APY and your balance, the more you'll earn. 

Also, most banks and savings institutions will compound the interest you earn, usually daily. This means that the interest that accrues each day is based not only on your principal account balance but also on the interest that has accumulated since the last payment.  

For example, let's say you have a $10,000 balance in a savings account with an interest rate of 5%. On the first day, your balance earns $1.37 in interest, and that gets added to your interest-earning principal—compounded—at the end of the day. That happens every day. 

By the end of the year, your principal will have grown to $10,512.67—$500 in interest on your principal balance, and $12.67 from the interest earned on your interest.  

 Calculation for daily interest rate: 

0.05 / 365 = 0.000136986 

 Calculation for first day’s interest: 

0.000136986 x 10000 = 1.36986 

 While your interest rate is 5% compounded daily; your total return including compounding, or annual percentage yield,  is 5.1267%. 

Compounding interest increases your savings over time, especially in a rising interest rate environment. 

Accrued Interest on Bonds 

If you're investing in bonds, interest is typically paid out every six months, and the amount that accrues between payments depends on the face value of the bond and its interest rate. This calculation is known as yield to maturity. 

Interest on bonds does not compound; that is, you don’t earn interest on your interest. 

How Accrued Interest Affects Borrowers 

If you borrow money, understanding accrued interest gives you an idea of how your loan's costs are incurred. As you make your regular monthly payments, for instance, the amount of interest that accumulates over time decreases. And if you make additional principal payments on top of your regular payments, you can reduce how much interest accrues even more.   

Keep in mind that, if you make an extra payment on a loan the lender may use some of that money to pay off the interest that has accrued since your last regular payment unless you specify otherwise. You can request that the lender put the full amount of your additional payment toward the principal balance, saving you more money on interest in the long run. 

Understanding how accrued interest works is particularly important if you have student loans. While college students aren't typically required to make monthly payments while they're still in school, interest accrues from the moment the loans are disbursed.  

For borrowers with federal subsidized loans, the federal government will typically pay interest that accrues while they're in school and during future deferment periods. If you have unsubsidized loans or private student loans, all the interest that accumulates while you're in school (and during periods of deferment or forbearance) is added to your balance once repayment begins.  

If you want to avoid a growing balance, consider making interest-only payments while you're still in school. 

How Accrued Interest Benefits Savers 

If you have an interest-bearing deposit account, look into how often (daily, weekly, monthly, quarterly, semi-annually, annually) your financial institution compounds the interest that accrues in your account. The more frequently interest is compounded (e.g., daily vs. quarterly) makes it possible for you to earn more interest more quickly. 

And if you've invested in bonds, understanding how accrued interest works can help ensure that you get the money you've earned, especially if you sell the bond between scheduled interest payments. For example, if you sell a bond three months after your last payment, you won't receive the amount of interest that accrued during that time. Because the buyer will receive the full semi-annual (every six months) interest payment despite only owning the bond for three months, they should pay you the amount that has accrued since your last payment on top of the price of the bond.

How Is Accrued Interest Calculated? 

On loans, lenders generally calculate interest on a daily basis using either a 360-day or 365-day year. The lender will divide the loan's interest rate by one of those numbers to determine your daily interest rate, which it then applies to your balance. 

On interest-bearing deposit accounts, interest generally accrues daily. Depending on how often your financial institution compounds interest, the amount that accrues each day may be calculated based on the principal balance plus previously accrued interest. 

What Is an Example of Accrued Interest?  

Let's say you have a personal loan with a $20,000 principal balance and a 12% interest rate. To calculate the amount of interest that accrues every day, you'll do the following equation: 

Calculation for daily interest rate: 

0.12 / 365 = 0.000328767123288 

Calculation for daily accrued interest: 

0.000328767123288 x $20,000 = $6.58  

 In other words, you'll have $6.58 in daily accrued interest. Over 30 days, that amounts to $197.40.