Normal (compound interest)

This method, also known as the actuarial method, is a method of computing interest charges in which interest is computed at regular intervals or at payment dates.

Under the Normal (compound interest) Compute Method, unpaid interest becomes part of the principal at the end of each compounding period. With monthly compounding, if the interest for a given month is $100 and only $75 is paid at the end of that month, then the $25 unpaid interest is added to the balance. Interest for the next month will be greater by the amount of interest on the additional $25. This compounding of interest makes sense since the borrower, in effect, receives an additional loan of $25 for a month. The resulting increase in principal due to unpaid interest is referred to as negative amortization.

With negative amortization, the lender is often said to be charging "interest on interest". Some states have laws that forbid charging interest on interest. So, in situations where payments are not large enough to cover current interest, use of the Normal (compound interest) Compute Method may not be legal and it may be necessary to use some other treatment, such as U.S. Rule.

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