Accrued interest is debt interest earned but not yet paid.
There is an important distinction to make between accrued interest and interest paid. Whilst interest paid has genuinely been repaid in cash by the borrower, accrued interest is a representative figure which indicatively shows the level of return you have generated based on the passing of time.
Accrued interest should not be considered earned until you actually have the cash in the bank. This is because the borrower could default on the interest payment (i.e. not pay it).
Simple example of an accrued interest calculation (annual interest payments)
For example, let’s imagine a scenario in which you have invested £1,000 in a P2P platform advertising a net interest rate of 5.0% paid annually.
After that 1 year period, you would be expecting an interest payment of £50.
After just six months, however, you would have received nothing. At this point, you are said to have accrued interest of £25 (i.e. half the interest due at the end of year, as half the investment period has passed).
Simple example of an accrued interest calculation (monthly interest payments)
When considering monthly interest repayments, the concept remains exactly the same.
Let’s take the same £1000 but this time, we invest in a hypothetical platform offering 0.7% net monthly interest.
If you invested on the first day of the month, you would expect to receive £7 interest (£1000 * 0.7%) on the last day of the month.
Just prior to receiving the monthly interest repayment on the last day of the month, you would have accrued interest of £7. At the point the interest then gets paid, your accrued interest balance would reduce to zero. This is because there is no longer a need for you to have a representation of interest earned – you have the actual interest earned in cash.
When time starts to pass in the second month of your investment, the accrued interest balance would again start to grow, reducing only when an interest payment is ultimately received.