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Exact interest is a process of calculating the interest on a debt based on a 365-day year. This is in contrast to other methods that may base interest on other time periods, such as 360 days. Understanding whether the lender uses an exact interest model is important to understanding exactly how a given interest rate is applied to the outstanding balance, which in turn can help applicants determine the true value of that interest rate.
The exact interest structure is slightly different from regular interest. Ordinary interest is based on the assumption of thirty days in each month of the calendar year. This leads to a situation where the interest rate application is based on 360 days. In contrast, exact interest allows the application to relate to the actual number of days found in the calendar year, not an average number of days per month in that year. Proponents of this approach consider this type of interest more accurate as it is based on specifics rather than using an average.
Although the difference between exact interest and ordinary interest creates only a small proportion, this proportion can become quite significant as the loan amount issued by the financial institution increases. This means that anyone who is buying a used car and financing it for a period of two years is unlikely to see much difference, regardless of the method used. At the same time, a company that is borrowing to build a new corporate headquarters will be very interested in whether the terms allow for the application of ordinary or exact interest, since the amount of interest paid on that large loan with terms of twenty to thirty years can be considerably higher, depending on which approach is used.
In general, exact interest is often applied to investments, such as government-sponsored bond issues or treasury bonds. Ordinary interest is most commonly used with personal loans, mortgages, and corporate bonds. Still, the regulations governing lending and investment practices in different countries allow some leeway in determining how to apply interest to the principal of the investment. For this reason, it is important to determine which method is identified in the contract governing the transaction and to determine how much interest will be due as a result. This end result might indicate that looking for a similar business that calculates interest based on a different method would be a good idea.