Calculating Effective Interest Rate

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Calculating Effective Interest Rate
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CalculatingEffective Interest Rate

OpenOffice Powerpoint Calculating Effective Interest Rate Edit: PAZ=Paddon Development Email: [email protected]

How to Calculate Effective Interest Rate
Calculation HelpCalculating Effective Interest Rate

How to Calculate Effective Interest Rate

Calculation HelpCalculating Effective Interest Rate http://www.wikihow.com/Calculate-Effective-Interest-Rate

Edited by Carolyn Barratt, A_F_Bob_Blair_Jr, Maniac, Chris and 5 others

When analyzing a loan or an investment, it can be difficult to get a clear picture of the loan's true cost or the investment's true yield. There are several different terms used to describe the interest rate or yield on a loan, including annual percentage yield, annual percentage rate, effective rate, nominal rate, and more. Of these, the effective interest rate is perhaps the most useful, giving a relatively complete picture of the true cost of borrowing. To calculate the effective interest rate on a loan, you will need to understand the loan's stated terms and perform a simple calculation.


Overview
Calculate The Effective Interest Rate Using The Following Formulae.

1 Calculate-Effective-Interest-Rate-Step-1-Version-2






- Effective Interest Rate Cheat Sheet

Stated Interest Rate Conversion Cheat Sheet


1 Familiarize yourself with the concept of the effective interest rate. The effective interest rate attempts to describe the full cost of borrowing. It takes into account the effect of compounding interest, which is left out of the nominal or "stated" interest rate. For example, a loan with 10 percent interest compounded monthly will actually carry an interest rate higher than 10 percent, because more interest is accumulated each month.

Calculate-Effective-Interest-Rate-Step-1-Version-2

The effective interest rate calculation does not take into account one-time fees like loan origination fees. These fees are considered, however, in the calculation of the annual percentage rate.


2 Determine the stated interest rate and number of compounding periods for the loan. These are the 2 important terms needed to calculate effective interest rate. The stated (also called nominal) interest rate will be expressed as a percentage. The compounding periods will generally be monthly, quarterly, annually, or continuously. This refers to how often interest is applied.




3 Familiarize yourself with the formula for converting the stated interest rate to the effective interest rate. The effective interest rate is calculated through a simple formula: r = (1 + i/n)^n - 1. In this formula, r represents the effective interest rate, i represents the stated interest rate, and n represents the number of compounding periods per year.



4 Calculate the effective interest rate using the formula above. For example, consider a loan with a stated interest rate of 5 percent that is compounded monthly. Using the formula yields: r = (1 + .05/12)^12 - 1, or r = 5.12 percent. The same loan compounded daily would yield: r = (1 + .05/365)^365 - 1, or r = 5.13 percent. Note that the effective interest rate will always be greater than the stated rate.



5 Familiarize yourself with the formula used in case of continuously compounding interest. If interest is compounded continuously, you should calculate the effective interest rate using a different formula: r = e^i - 1. In this formula, r is the effective interest rate, i is the stated interest rate, and e is the constant 2.718.



6 Calculate the effective interest rate in case of continuously compounding interest. For example, consider a loan with a nominal interest rate of 9 percent compounded continuously. The formula above yields: r = 2.718^.09 - 1, or 9.417 percent.


Effective Interest Rate Cheat Sheet

http://www.wikihow.com/Sample/Effective-Interest-Rate-Diagram

Strategy

Summary


Stated Interest Rate Conversion Cheat Sheet

http://www.wikihow.com/Sample/Stated-Interest-Rate-Conversion-Diagram

Strategy

Summary

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Calculating Effective

Interest Rate

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Calculating Effective Interest Rate

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