Interest accrual

Interest accrual is the process by which interest charges build up on a loan balance over time. Interest accrues continuously — usually calculated on a daily basis — even if repayments are made monthly or quarterly.

How accrual works in practice

Each day, the lender calculates the interest owed on the current outstanding balance using the daily rate (annual rate ÷ 365). This amount accrues but is not necessarily charged immediately. At the end of the billing period — typically a month — the total accrued interest is applied to the account.

When a borrower makes a repayment, the payment is first applied to any accrued interest, and the remainder reduces the principal. This is why early in a loan term a large portion of each repayment goes toward interest rather than principal: the accrued interest must be cleared before principal reduction begins.

Accrual vs compounding

Interest accrual and compounding are related but distinct concepts:

• Accrual refers to the build-up of interest charges on a balance over time
• Compounding occurs when accrued interest is added to the principal, causing future interest to be calculated on a higher balance

Most consumer loans (personal loans, car loans, home loans) accrue interest daily but compound it monthly — interest for the month is added to the account once, and only then does the new balance become the basis for the next month’s accrual. Credit cards more commonly compound daily, meaning unpaid interest from one day is added to the balance and itself begins accruing interest immediately.

The effect of timing on accrual

Because interest accrues daily, the timing of repayments affects the total interest paid. Making a repayment earlier in the month (or fortnight) reduces the outstanding balance for more days, resulting in less interest accruing during that period. Even small timing differences compound over a loan term.

For the same reason, direct-debit repayments timed to arrive immediately after payroll — rather than at the end of the billing cycle — can meaningfully reduce total interest paid on short-term loan products.