With monthly compounding, interest is calculated and added to your balance once a month. From then on, that interest is part of the balance and earns interest itself. Over a year this adds slightly more than the quoted annual rate.
Step 1: find the monthly rate
For a nominal annual rate compounded monthly, the monthly rate is simply the annual rate divided by 12:
Monthly rate = annual rate ÷ 12
A 6% annual rate means 0.5% per month.
Step 2: add interest each month
Here is $1,200 at 6% compounded monthly:
| Month | Opening balance | Interest (0.5%) | Closing balance |
|---|---|---|---|
| 1 | $1,200.00 | $6.00 | $1,206.00 |
| 2 | $1,206.00 | $6.03 | $1,212.03 |
| 3 | $1,212.03 | $6.06 | $1,218.09 |
| … | … | … | … |
| 12 | $1,274.01 |
Each month’s interest is a little larger than the last. After 12 months the balance is $1,274.01 — that is $74.01 of interest, compared with $72.00 at 6% simple interest.
The formula
Instead of stepping through every month, use:
A = P × (1 + r/12)12 × t
For our example: 1,200 × 1.00512 = $1,274.01.
Effective annual rate
Because of monthly compounding, a 6% nominal rate actually grows money by:
(1 + 0.06/12)12 − 1 = 6.1678%
This is the APY. When a bank advertises “6.00% interest, 6.17% APY”, the difference comes from monthly compounding.
Monthly compounding on loans
Loans such as mortgages calculate interest monthly on the outstanding balance. Because your monthly payment covers that interest, it is not added to the balance and does not compound. If you miss a payment, or on a credit card if you pay less than the interest charged, the unpaid interest joins the balance and starts compounding.
Monthly vs daily compounding
Many savings accounts calculate interest daily but credit (add) it monthly. In that case interest only compounds when it is credited, so the result is essentially monthly compounding. True daily compounding adds very little extra — see Daily vs Monthly vs Annual Compounding.
Key takeaways
- Monthly rate = annual rate ÷ 12; interest is added 12 times a year.
- Each month’s interest is calculated on a slightly bigger balance.
- The effective annual rate is higher than the quoted rate: 6% becomes 6.17%.
See any balance month by month with the Monthly Interest Calculator, or project it over years with the Monthly Compound Interest Calculator.