Effective Rate of Interest Calculation

effective rate of interest calculationEffective Rate of Interest Calculation

An effective rate of interest calculation 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 Rate Formula

Effective annual interest rates are calculated in the two following ways:

1. Effective Rate = Total Interest Paid / Principal Amount

2. Effective Rate = (1 + i / n)n – 1

(Where i 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%. So, look at the following calculation:

.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%. Look at the following calculation:

.1047 = (1 + .10/12)12 – 1

If you want to overcome obstacles and prepare how your company is going to react to external factors, then download your free External Analysis whitepaper.

effective rate of interest calculation

Strategic CFO Lab Member Extra

Access your Projections Execution Plan in SCFO Lab. The step-by-step plan to get ahead of your cash flow.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

effective rate of interest calculation

See Also:
What is Compound Interest
When is Interest Rate Not a Important in Selecting a Loan?
Nominal Interest Rate
Interest Rate Swaps
Fixed Interest Rate vs Floating Interest Rate

, ,

No comments yet.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.