Daily compound interest is a type of continuous compound interest that is applied to loans and investments. In the financial world, interest is money that a borrower pays as a premium for having access to the borrowed sum. Interest is usually calculated as a percentage of the total amount on loan, but varies in terms of rate and frequency of calculation. A daily compound interest rate is interest that is calculated every single day of the loan, then added to the principal amount. As such, the principal grows bigger every day, and with it the total interest charged.
All forms of compounding interest are based on the concept of a principal that grows throughout the duration of the loan. Every time interest is assessed, that interest amount is added to the principal, so that the next time interest is assessed, the percentage is based off of a slightly bigger number. For interest that is compounded daily, this means that every day, the borrower owes just a little bit more in interest.
The formula for calculating compound interest can be expressed as V=P(1+R/N)NT, where “V” is the future value of the investment; “P” is the original principle; “R” is the interest rate, in decimal form; “N” is the number of times per year that interest is compounded; and “T” is the total duration of the loan, in years. For daily compound interest, “N” would be 365. Because this number is so large, the degree of daily change to the principal is not likely to be more than a fraction of a percent. Over time, however, and depending on the initial size of the principal, daily compound interest can add up to significant sums.
Daily compound interest is most commonly found in credit card scenarios. Credit card companies often advertise their annual percentage rate, or APR, as a certain fixed number. Although it is called an annual rate, the APR is usually compounded much more regularly than once a year. The majority of credit card companies compound their annual interest either monthly or daily.
For small amounts of money, there is rarely much of a tangible difference between monthly compound interest and daily compound interest. The rate of compounding matters most when there is a lot of money at stake and when the interest rate is high. For this reason, it is important to understand not just the percentage rate of a loan, but also the compounding schedule.
Often times, investors in long-term loan instruments such as bonds, mutual funds, or certificates of deposit will have some say in the interest structure. Daily compound interest is almost always the most favorable, but the best deal depends on more factors than just the rate of compound. A higher interest rate that compounds once a month or twice a year may actually yield more at the end of the period than loans offered at lower interest rates that compound daily.