Finance

Effective Interest Rate and Its Common Uses

The effective interest rate reflects the full price of the loan in terms of interest (a percentage of the principal). The effective interest rate takes into account all of the added or accompanying expenses related to the loan. The common expenses are as follows:

Table 1.2

Type of expense (The percentages and amounts are only examples)
Credit allocation charge 5% of the principal (The percentage is made significantly higher than usual for purposes of the example)
Stamp fees 1% of the principal (The percentage is made significantly higher than usual for purposes of the example)
Fee for opening a file $100
Insurance $300
Payment for a credit framework $6 per quarter


The date on which we must pay the charges also affects “the real price”.

The earlier the payment date (for example, when charges are paid in advance), the higher “the real price”.

Effective Interest Rate and Its Common Uses521Effective Interest Rate and Its Common Uses