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Effective Interest Rate Formula:
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The Effective Interest Rate (EIR) represents the true cost of borrowing or the true return on investment, accounting for the effect of compounding. It provides a more accurate measure than the nominal interest rate.
The calculator uses the EIR formula:
Where:
Explanation: The formula calculates the annual interest rate when compounding is taken into account, showing the actual financial cost or return.
Details: Accurate EIR calculation is crucial for comparing different loan or investment products, understanding the true cost of borrowing, and making informed financial decisions.
Tips: Enter the nominal annual interest rate as a decimal (e.g., 0.05 for 5%), and the number of compounding periods per year as an integer. All values must be valid (r ≥ 0, m ≥ 1).
Q1: Why use EIR instead of nominal rate?
A: EIR accounts for compounding effects, providing a more accurate representation of the actual interest cost or return compared to the nominal rate.
Q2: What are typical EIR values?
A: EIR values vary widely depending on the nominal rate and compounding frequency. Generally, EIR is higher than the nominal rate when compounding occurs more than once per year.
Q3: How does compounding frequency affect EIR?
A: More frequent compounding results in a higher EIR, as interest is calculated on previously earned interest more often.
Q4: Are there limitations to this calculation?
A: This calculation assumes constant interest rates and regular compounding periods. It may not account for fees, variable rates, or irregular compounding schedules.
Q5: Should EIR be used for all financial comparisons?
A: Yes, EIR is the standard metric for comparing different financial products as it reflects the true cost or return, making it easier to compare options with different compounding frequencies.