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Effective interest rate that a borrower actually incurs in a year after adjusting to compounding.
When it comes to dealing with a bank, interest rates are never simple to comprehend.
There are so many jargon to describe different ways interest is calculated. For example:
- Reducing rate
- Simple rate
- Flat rate
The effective interest rate (EIR) is another one of such.
It is important to investor, home buyers, and banks, because it get more detailed into how much interest costs is actually at stake with the home loan.
Because a mortgage has it’s interest rate calculated on a monthly basis (unless otherwise stated), a 1.20% interest will have a monthly rate of 0.10%.
When that is compounded 12 times a year, the result is that the borrower actually pays slightly more at 1.2066%.
This is the effective rate.
i = annual interest rate
n = number of compounding periods
As can be observed from the formula above, the higher the number of compounding periods, the higher the resulting EIR.
for the last 36 months?
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