How to Understand Interest That Is "Accrued Daily and Compounded Monthly"

As you earn interest on your savings, it would be nice to know when that interest is added to your account and how fast the account will grow. The accrual and compounding terms of an account, along with the interest rate, determine the total earnings on your money. Daily accrual with monthly compounding are commonly used factors for interest earnings.

Accrued Interest

The interest accrual terms indicate how often interest is added to an account balance. Daily accrual means that interest is added to the account balance every day. The rate of interest earned will be the annual interest rate divided by 365. If you have an account earning 6 percent interest, the account will accrue interest at a rate of 0.01644 percent each day. The amount of daily interest will be the same each day of the stated compounding period.

Compounding Interest

Compound interest is earning interest on the amount in the account plus additional interest that has been earned. If interest compounds monthly, the account value on which the interest is to be earned is calculated on a new value each month. On the compound date, the daily interest accrual amount will increase based on the account value plus the interest accrued over the previous month. The amount of daily interest accrual increases each month on the compounding date.

Accrual and Compounding Example

You have a savings account with a current balance of $10,000 earning 10 percent interest accruing daily and compounding monthly. The daily interest rate is 0.0274 percent. For the first month the account will accrue $2.74 of interest each day. After 30 days, the accrued interest of $82.20 is compounded to the account and interest for the next month is calculated on a value of $10,082.20. In the second month, interest will accrue at a rate of $2.76 per day -- 10,082.2 times 0.0274 percent. Total interest earned in a 31 day second month will be $85.63, bringing the account total to $10167.82. Interest will accrue in the third month at a daily rate of $2.79.

Types of Accounts

Interest accrued daily with monthly compounding works with both savings accounts and debt accounts such as credit card balances. With a debt balance, any payments will reduce the balance and the accrued interest for the month will increase the balance. The daily interest amount will be calculated on the new balance. An acceptable accounting practice is to use either a 360-day or 365-day year to calculate the daily interest rate. Check the fine print on your account to determine how the daily interest rate is calculated.

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