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Effective Annual Rate Formula:
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The Effective Interest Rate Calculator With Extra Payments calculates the annual equivalent rate (AER) considering the impact of extra payments that reduce the principal amount. It provides a more accurate representation of the true cost or return of a financial product.
The calculator uses the effective annual rate formula:
Where:
Explanation: The formula calculates the effective annual rate by accounting for the effect of compounding periods throughout the year, while extra payments directly reduce the principal amount being financed.
Details: Calculating the effective annual rate is crucial for comparing different financial products with varying compounding frequencies. It provides a standardized way to understand the true cost of borrowing or the true return on investment.
Tips: Enter the principal amount in currency, annual interest rate as a decimal (e.g., 0.05 for 5%), compounding frequency per year, and any extra payment amount. All values must be valid positive numbers.
Q1: Why calculate effective annual rate instead of nominal rate?
A: The effective annual rate accounts for compounding effects, providing a more accurate representation of the true cost or return compared to the nominal rate.
Q2: How do extra payments affect the effective interest rate?
A: Extra payments reduce the principal amount, which effectively lowers the total interest paid over time and can significantly improve the effective interest rate from the borrower's perspective.
Q3: What's the difference between APR and effective annual rate?
A: While both measure borrowing costs, APR includes fees and other costs, while effective annual rate focuses specifically on the impact of compounding frequency on the interest rate.
Q4: Can this calculator be used for investments as well as loans?
A: Yes, the effective annual rate calculation works for both borrowing costs and investment returns, providing a standardized way to compare different financial products.
Q5: How often should compounding frequency be considered?
A: Compounding frequency significantly impacts the effective rate. More frequent compounding (daily vs. annually) results in a higher effective rate for the same nominal rate.