Accrued Interest
Accrued interest refers to the amount of interest a borrower owes to a lender by a specific date. The concept extends beyond real estate. For instance, student loans, credit cards, certificates of deposit, accrue interest. Interest accumulates daily throughout the month, typically, borrowers receive a statement on the last day of the month that details the interest due, along with any required principal payments.
Acquiring Real Estate
In real estate, investors typically acquire a property using a mix of debt and equity. Investors usually secure loans through a private lender or financial institution. Investors usually contribute equity through their own capital.
Importance of Accrued Interest
Real Estate generates income leasing spaces to tenants and collecting rents. However, owning real estate also comes with various costs, such as financing. Investors must be aware of monthly financing costs and other expenses. Overlooking the other expenses may impact the ability to pay back the lender.
Lender (Payment Recipient) Accounting: When lenders issue loans, they appear as assets on their balance sheets. This is due to the interest earned on top of the principal amount of the loan, assuming borrowers repay them fully and on time.
Borrower (Paying Entity) Accounting: From a borrower’s perspective, a loan represents a liability on a balance sheet. As the borrower makes their monthly payments, the loan balance and liability will decrease over time.
Accrued Interest vs. Regular Interest
In real estate investments, investors must be aware of the monthly interest payments. Doing so ensures investors are able to create accurate financial projections and precisely estimate cash flows.
Accrued interest is the amount of interest accumulated on a loan that has not yet been paid. In contrast, regular interest is defined as interest that a lender earns/borrower pays. Student loans is an example of a loan with accruing interest, since the payments do not start until after the student graduates. Regular interest can also be seen as the cash income a lender receives or the cash cost a borrower pays for interest. Overall, accrued interest is identified and recorded to be paid at a different date, while regular interest is paid on a consistent basis.
An example of a loan with accruing interest is a student loan, as payments typically begin only after the student graduates. Regular interest acts as cash income received by the lender or the cash cost incurred by the borrower for interest. Overall, accrued interest is identified and recorded for payment at a later date, whereas regular interest is paid on a consistent basis.
For retail real estate investors, understanding accrued interest plays a crucial role in effective financial planning and investing. Since accrued interest represents accumulated unpaid interest, accurately evaluating accrued interest helps investors better manage cash flows and anticipate expenses. This allows investors to optimize returns and avoid pitfalls – enhancing rates of return.
