Interest capitalization, popularly known as "interest on interest", is a kind of method for calculating interest on a bank deposit. Within the framework of the system, the growth of the contribution does not occur once, but gradually - at certain intervals and taking into account special factors.
Interest capitalization implies a monthly, quarterly or annual increase in the amount of the deposit, taking into account the addition of accrued interest to it. This is followed by a recalculation of the further amount of accruals in accordance with the amount accumulated by that moment. Thus, as a result, the bank's client will receive an amount increased not by a specific, but by a floating percentage.
As an example, you can take a deposit of 100,000 rubles at 12% per annum with monthly accrual and recalculation of interest. Under normal conditions of the deposit, the profit received in 12 months will be 12,000 rubles (100,000 * 0, 12). In this case, interest is usually charged in the same amount on a monthly basis. If, according to the terms of the deposit, the capitalization of interest is provided, the calculation of interest will be made in the following order:
- for the first month: 100,000 * 0, 12/12 = 1,000 rubles;
- for the second month: (100000 + 1000) * 0, 12/12 = 1010 rubles.
- for the third month: (100000 + 1000 + 1010) * 0, 12/12 = 1020, 1 rubles, etc.
This is how the monthly capitalization of interest will look like, however, the agreement may provide for quarterly or annual capitalization, the principle of calculating which, however, will be the same.
There is also a more complex formula for calculating the capitalization of interest:
total deposit amount = (1 + P / 100) * N, where P is the percentage accrued for the capitalization period (month, quarter or year), and N is the total number of recalculation periods within the deposit. At the same time, it is worth remembering that banks most often indicate an annual percentage in the agreement, even if the deposit is opened for a shorter period. Therefore, when opening a savings account at 12% per annum with quarterly capitalization and only for 6 months, the formula for calculating the resulting amount will be as follows: (12/4/100) * 2.
From the calculations made it can be seen that the interest accrued during capitalization will also be added to the existing deposit amount, and the next interest is calculated from the new amount. One way or another, the contribution will bring a greater return than with standard and non-capitalized interest.
One and the same bank most often offers the opportunity to draw up a deposit with or without interest capitalization. To make the right choice, you should think about how you plan to dispose of the deposited amount: capitalized deposits do not always provide for the possibility of monthly withdrawal of interest, but in the end they bring more profit than simple ones. In the case of standard savings accounts, the accrued interest can usually be withdrawn on a monthly basis, but the total amount will be less than with capitalization.
