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How would you deal with the month of February in a daily interest calculation on a loan that compounds monthly?

I would think that with 30/360 day count convention, each day in February results in accruing "more daily interest" than usual because you are spreading a month's worth of interest across 28 days instead of 30.

For example, say you borrowed $100 on 2/1/2017 and it carries a 12% interest, compounded monthly. This effectively should mean you accrue $1 worth of interest at end of February, resulting in end balance of $101, and then 1% again on that $101 at the end of March, for end balance at 3/31/2017 of $102.01. Below is a sample calculation.

Notice that the daily interest in February is higher than the daily interest beginning 3/1. Is this the correct way to accrue interest in February? I understand in months like March, you don't accrue on the 31st, but want to figure out properly how to calculate the end balances on certain dates.

February accrual sample

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    If the loan agreement calls for monthly compounding at an APR x% based on a 30/360 convention, then all you need to do is accrue (x/12)% interest a the end of each month, and not accrue interest on a daily basis. Most people (in the US) are cash basis taxpayers and not accrual-basis tax payers, and so your question is not relevant to them. If you are asking about managing a company's accounts on an accrual basis, then your question is off-topic on money.SE Apr 4, 2017 at 22:37
  • 12th root of X, actually.
    – keshlam
    Mar 13, 2023 at 23:11

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For accrued interest "30E/360" is what the method to standardize on 30-day months is called. It is almost never used. Accrued interest/360 is used, but more common is accrued interest/365. With these methods the result is nominal daily interest and it is multiplied by 28 for February (or 29).

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    Interest rate swaps including Libor and Euribor have 30/360 as the most appropriate basis for calculating interest accrual on fixed payments and it's the most common method for corporate bonds, muni and agency bonds on the US.
    – AKdemy
    Mar 13, 2023 at 21:04
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Under "pure" 30/360, 1/30 of the interest for the month (using the annual rate / 12) is accrued each day. In February with 28 days, that means that 3 days' worth of interest accrues between Feb 28 and Mar 1, depending on the start date of the accrual period. It also means that no interest accrues between Mar 30 and Mar 31. This ensures that the daily interest is easy to compute (APR/360) and the monthly interest is consistent (APR/12).

There are "flavors" of 30/360 that treat February differently by dividing the monthly interest by 28, but that means that days in February accrue more interest daily than other months. So it's a tradeoff between consistency between the months and a lack of gaps or jumps at the end of different months.

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