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Effective Interest Rate Formula:
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The Effective Interest Rate (EIR) represents the actual annual interest rate when compounding is taken into account. It provides a more accurate measure of the true cost of borrowing or the real return on investment compared to the nominal interest rate.
The calculator uses the Effective Interest Rate formula:
Where:
Explanation: The formula accounts for the effect of compounding by calculating the interest earned on both the principal and the accumulated interest over multiple compounding periods.
Details: Calculating the effective interest rate is crucial for comparing different financial products, understanding the true cost of loans, and evaluating investment returns accurately. It helps consumers and investors make informed financial decisions.
Tips: Enter the nominal annual interest rate as a decimal (e.g., 0.05 for 5%), and the compounding frequency per year (e.g., 12 for monthly compounding). All values must be valid (r > 0, n ≥ 1).
Q1: What's the difference between nominal and effective interest rate?
A: The nominal rate doesn't account for compounding, while the effective rate reflects the actual interest earned or paid when compounding is considered.
Q2: How does compounding frequency affect the EIR?
A: More frequent compounding results in a higher effective interest rate, as interest is calculated and added to the principal more often.
Q3: When is EIR calculation most important?
A: EIR is particularly important when comparing loans or investments with different compounding periods, as it provides a standardized comparison.
Q4: Can EIR be lower than the nominal rate?
A: No, the effective interest rate is always equal to or higher than the nominal rate due to the effect of compounding.
Q5: How is EIR used in financial regulations?
A: Many countries require financial institutions to disclose the effective interest rate to help consumers understand the true cost of credit products.