What is accrued interest?

When looking at your bank statement, you might wonder, "What is accrued interest?" It may sound intimidating, but we promise — it isn’t tricky to understand!

Learning what accrued interest is can help you make smarter financial decisions. For example, understanding how much interest is building up on your debts can motivate you to pay them off faster. Or, seeing how much interest your savings are earning might inspire you to save even more!

So, let’s jump into how to calculate accrued interest and how to manage it on both the savings side and the loan side.

Accrued interest: A friend or foe?

The first thing you’re probably trying to figure out is if accrued interest is good or bad. And the answer is: It depends.

Let's start with a simple accrued interest definition: It's just the interest that adds up on your loan or investment over time. You know how your kids and teens grow a little bit each day until one day, bam! They're taller than you? That’s how accrued interest works. It builds up day by day, month by month.

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Accrued interest could be good or bad, depending on whether you're losing or gaining it. For instance, let's say you've got a savings account (go you!) or maybe a bond (super!). The money you're earning on those isn't paid out to you every single day, but it's still growing. That's your accrued bond interest — or, all those savings added up. 

On the flip side, if you've taken out a loan — maybe for a new family car or that home renovation you've been dreaming of — the interest on that loan is also accruing, even between your monthly payments. This is definitely the type of accrued interest you want to avoid as much as possible!

What exactly is accrued interest?

The term "accrued interest" refers to any unpaid interest that has been added to your account balance after a certain date. Before we go into more detail, though, let’s take a step back and define interest more generally. At its core, interest is the amount of money someone charges to lend money. When you take out a loan from a bank, they'll charge you an interest fee. On the other hand, when you buy bonds, you're lending money to a company that will pay you an interest fee. 

Now, there are three main types of interest:

• Simple interest: Also known as regular interest, this is the amount of interest due on the loan according to the outstanding principal (the amount that hasn't been paid back yet). For example, if you buy a $1,000 bond that pays 6% in interest per year, you would receive a one-time $60 payment per year. The $60 payment won’t be reinvested unless you put it somewhere else.

• Compound interest: This type of interest uses the principal of the loan, plus any previously earned interest. Let’s say you have a high-yield savings account with compound interest. The interest you make will be automatically added to your balance daily, so you'll earn something each day. If the example above had compound interest, then you’d be earning a total of $61.83 in your first year instead of just $60. Yay! On the other hand, credit cards typically use compound interest for any balance you carry over. That’s why you should always pay your credit card in full!

• Accrued interest: This refers to the interest that an account generates before reinvesting or paying out money. For example, student loans accrue interest throughout the month. However, this interest won’t generate additional interest — only the principal will. You can think of this as an intermediate between simple and compound interest.

Accrued interest on savings and investments

Accrued interest on your savings and investments usually comes once a month. You can then choose to spend or reinvest this money. Ideally, you want to reinvest your earned interest, as this will help your money grow even faster.

Accrued interest on loans

Accrued interest is the most common type of interest for loans. If you’ve taken out loans before, you may have noticed that the outstanding balance seems to go down very slowly (if at all), even if you make monthly payments. That’s because the monthly payment is typically made up of mostly accrued interest, especially if your loan has a high interest rate (in which case, you may want to look into getting a cosigner!).

Picture this: You have a $30,000 student loan with a 6% interest rate. In the first month, your loan will generate $150 in interest. If your monthly payment is $180, then that means that your outstanding principal will only go down by $30 after your first payment (yikes!).

Why should you care about accrued interest?

For many, it’s so hard to get out of debt because they don’t understand how loans generate interest. Understanding how accrued interest works will help you better manage your loans or investments. 

Let's go back to our example from above. It may seem like paying $180 per month will quickly make a dent in the outstanding principal, when it’s actually only going to cover 0.10% of it. Understanding how accrued interest works can give you the motivation to repay your debt faster or invest your money more wisely.

The impact of accrued interest on your debt

Let’s take our student loan example one step further. 

If you make a monthly payment of $180 on a $30,000 student loan with a 6% interest rate, it will take you 30 years to repay the entire loan. By the end of the 30 years, you will have paid a total of $64,635.94 — meaning you’ve paid much more in interest than the amount you originally borrowed!

On the other hand, raising your monthly payment to $250 will cut both your repayment time and total payment amount in half. It will take you just over 15 years to repay a total of $45,956.62, which is almost $20,000 in savings from the other scenario. That’s the power of accrued interest — just $70 a month can make a massive difference!

The power of accrued interest on your savings

You've seen that adding a little bit extra to your loan payments each month can have massive results in the long run. The same goes for your savings — increasing what you invest can add up over time. If you invest $180 a month into an account that accrues interest monthly at 6%, you’ll end up with $52,609.11 after 15 years. If you bump up the monthly investment to $250, then you’ll end up with $73,068.20. Once again, just $70 per month can take you far!

Watching your money grow

So, what does this all mean for you? Well, for one, you can think about how to add just a little more to your savings. Then, sit back and watch your money grow. As you invest more and more of your hard-earned cash, nothing will inspire you to ramp up your investments like seeing how much money you’ve earned from interest — all without lifting a finger.

Harnessing the power of accrued interest

That's it! Now that you understand how accrued interest works, it’s time to make some smart money moves to get yourself one step closer to financial freedom. Remember, accrued interest is paid out or charged periodically, so you want to keep a close eye on how your investments or loans are growing. 

Want to pass on money smarts? Don’t hesitate to have early conversations with your kids and encourage them to learn about finance so they can hit the ground running when they’re old enough to start spending on their own. Or, even better, with Greenlight Infinity, they can earn 5% on savings* and see the benefits of accrued interest all on their own. Infinity also comes with helpful tools like an educational app, family location sharing, and SOS alerts.

Ready to learn about the world of money? Sign up for Greenlight today!

Greenlight is a financial technology company, not a bank. The Greenlight app facilitates banking services through Community Federal Savings Bank (CFSB), Member FDIC.

*Greenlight Core families can earn 2% per annum, Greenlight Max families can earn 3% per annum, and Greenlight Infinity families can earn 5% per annum on an average daily savings balance of up to $5,000 per family. To qualify, the Primary Account must be in Good Standing and have a verified ACH funding account. See Greenlight Terms of Service for details. Subject to change at any time. **Greenlight Max and Infinity families can earn 1% cash back on spending monthly. To qualify, the Primary Account must be in Good Standing and have a verified ACH funding account. See Greenlight Terms of Service for details. Subject to change at any time. ***Requires mobile data or a WiFi connection, and access to sensory and motion data from cell phone to utilize safety features including family location sharing and driving alerts and reports. Messaging and data rates and other terms may apply.