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Effective Interest Rate Formula:
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The Effective Interest Rate (EIR) represents the true cost of borrowing by accounting for the effect of compounding. It provides a more accurate measure of interest costs compared to the nominal rate, especially for personal loans with frequent compounding periods.
The calculator uses the EIR formula:
Where:
Explanation: The formula calculates the actual annual interest rate when compounding occurs more frequently than annually, providing a true representation of borrowing costs.
Details: Calculating EIR is crucial for comparing different loan offers, understanding the true cost of borrowing, and making informed financial decisions when choosing personal loans.
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 is EIR higher than the nominal rate?
A: EIR accounts for compounding effects, which means interest is calculated on both principal and previously earned interest, resulting in a higher effective rate.
Q2: How does compounding frequency affect EIR?
A: More frequent compounding (higher m) results in a higher effective interest rate, as interest is calculated and added more often.
Q3: When should I use EIR instead of nominal rate?
A: Always use EIR when comparing different loan options, as it provides a standardized measure of true borrowing costs across different compounding frequencies.
Q4: Can EIR be converted to APR?
A: EIR and APR (Annual Percentage Rate) are similar concepts, though APR may include additional fees. EIR focuses specifically on the interest compounding effect.
Q5: What are typical compounding frequencies?
A: Common frequencies include annual (m=1), semi-annual (m=2), quarterly (m=4), monthly (m=12), and daily (m=365) compounding.