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4 Things You Need to Know About Accrued Interest

By    |   Saturday, 13 June 2015 08:01 PM

Accrued interest, defined as interest that an investor has earned but has not yet received, is important to understand in planning for retirement. It can also mean interest that has piled up over time on a loan as a borrower seeks to pay it down to its principal.

Here are four things you should know about accrued interest.

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1. It can be a complicated equation for bond buyers.
A bond owner often must be paid the accrued interest first before the bond is transferred to another investor, according to Investopedia.

Investopedia notes that bond interest becomes compensation for money that was lent to a borrower. When a bond matures, that money gets paid to the bondholder. By turn, an interest payment goes to the person who owns the bond at the time of its maturity. If that happens before maturity, sellers get what is referred to as its market value.

2. It doesn't stop.
While a loan is being paid off, interest continues to accrue during that payoff period. For that reason, lenders urge borrowers to pay more toward their principal to offset the interest that adds to the overall balance over time.

3. Calculators can help.
Some lenders such as Sallie Mae offer accrued interest calculators online that help borrowers to understand how it affects their overall loan repayment. Often such a calculation is eye-opening.

Others from organizations such as FINRA (Financial Industry Regulatory Authority) offer calculators for bond accrued interest.

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Bond interest can also be calculated manually. Investors can begin by determining the daily interest rate. That is done by "using a 30-day month and 360-day year, and then multiplying by the number of days remaining before the next coupon date," Investopedia said.

The website explained the equation: "For a bond with an interest rate of 5 percent, paying semi-annually, each payment is equal to $25, or $50 annually, broken into two payments. If the buyer is purchasing the bond on May 1 and the interest payment is due June 1, the accrued interest is calculated as follows: ($1,000 x 5 percent) x (122 / 360) = $16.94. Since interest accrues through the day before the settlement date, 122 days are used."

4. Issuers of bonds are not involved in paying accrued interest. Accrued interest "is paid by the buyer of a bond to the seller," MunicipalBonds.com notes.

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Accrued interest, defined as interest that an investor has earned but has not yet received, is important to understand in planning for retirement.
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Saturday, 13 June 2015 08:01 PM
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