What is Compound Interest
When is Interest Rate Not as Important in Selecting a Loan?
Nominal Interest Rate
Interest Rate Swaps
Fixed Interest Rate vs Floating Interest RateEffective Rate of Interest Calculation
An effective rate of interest
is the actual cost of a loan. It is the total amount of interest paid
on a loan, expressed as a percentage of the principal. Effective annual interest rates incorporate the effects of compounding. Effective annual interest rates are calculated in two ways:Effective Annual Rate Formula
1. Effective Rate = Total Interest Paid / Principal Amount
2. Effective Rate = (1 + i / n)n – 1
is the nominal rate and n
is the number of compounding periods per year.)
For example, using the first formula, if the starting principal amount is $1,000 and the total interest paid over the course of the year is $104.70, then the effective interest rate is 10.47%.
.1047 = 104.7 / 1000
Using the second formula, if the starting principal amount is $1,000, the nominal annual interest rate is 10%, and the rate is compounded monthly, then the effective annual rate is 10.47%.
.1047 = (1 + .10/12)12 – 1