How Do You Calculate Effective Interest Rate?
• 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. • 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. • 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 inte
