What is the effective annual interest rate?
A loan is an optimal way to be able to finance purchases in a timely manner, for which you would otherwise have to save for years or decades. The focus is on the time factor, because nothing is more valuable than life time. Nevertheless, it must be remembered that loans are not selfless gifts. Every bank makes sure that it can check the creditworthiness of a customer and the lending is linked to certain conditions, but above all to certain interest rates. In this way, the bank ensures that it also earns money from this loan and that the business is worthwhile for both parties.
The effective annual interest rate and the borrowing rate
In order to have a better overview of the costs of loans, customers have to pay attention to all interest rates. The calculation of the total interest would only be easy if a loan was repaid with a one-off payment after one year. However, this is never the case and so other interest rates are included and divided over the duration of the repayments. The borrowing rate plays a particularly important role here. The relative borrowing rate is the quotient of the annual percentage rate and the number 12. This reduces the interest rate on loans to one month.
The compound interest
In the country, however, as everywhere else, customers have to consider additional costs, namely compound interest. A bank usually loses profits by paying off the first installments of a loan very early. As a result, only the simple interest rate applies. In order to compensate for these financial losses, the remaining debt will again bear interest. This results in compound interest, which is added to the simple interest rate. In this way, the bank compensates for early losses through a later increase in the relative interest debt.
Anyone looking for a loan in the country must also consider other costs. In addition to interest on loans, fees also apply to every bank. Banks view the working hours of employees and the necessary papers as additional expenditure on their part, which they invoice the customer. Although these are not large amounts, they still count towards the entire invoice and can make up a significant percentage, especially for very small loan amounts.
The contractual terms
With every loan there are other conditions, which refer mainly to early repayments. As a result, the effective annual interest rate is only one factor among many that make up the absolute interest debt.