Accrued Interest
Definition
Accrued interest is the interest that accumulates on a loan or investment over a specific period but has not yet been paid.
Detailed Explanation
Accrued interest is a financial term representing the interest amount that is incurred over a period of time but has not yet been paid. In other words, it is the interest that is owed to the lender, calculated from the last payment made up until the present time.
In student loans, accrued interest happens every day - the loan balance will show the interest accruing on the loan each day the balance exists.
Accrued interest calculation is generally straightforward. It involves multiplying the principal amount (the initial loan) by the interest rate and then by the fraction of the payment period that has passed (e.g. 1/365). This provides a more precise and fair valuation of the financial positions, ensuring that obligations are recognized appropriately.
Example
Imagine a scenario where a person takes out a loan of $20,000 with an annual interest rate of 6%. If three months have passed since the loan was taken out, the accrued interest can be calculated to determine the amount of interest that has accumulated on the loan during this period, even though it hasn't been paid yet.
This is very similar to what happens when you take out a student loan and are in-school not making payments.
In this case, the accrued interest would be calculated by multiplying the principal amount ($20,000) by the interest rate (6% or 0.06) and then by the fraction of the year that has elapsed (0.25, as three months is a quarter of a year). The calculation would be:
Accrued Interest = $20,000×0.06×0.25 = $300
So, $300 is the amount of interest that has accrued on the loan in three months. This amount is recognized as a liability for the borrower (the person who took out the loan) and an asset for the lender (the bank), although no cash transaction of this interest payment has occurred yet. The borrower will need to pay this interest amount in addition to the principal amount, as per the terms and conditions of the loan agreement.
Key Articles Related To Accrued Interest
Related Terms
Amortization: The process of paying off a debt over time through regular payments.
Capitalization: The process of accrued interest being added to the principal loan balance.
Interest Rate: The percentage of the loan amount that lenders charge as a cost for borrowing.
Principal: The original amount of money borrowed before any interest or fees are added.
Editor: Colin Graves Reviewed by: Chris Muller
