What Is Effective Interest Rate On Loan And How Is It Calculated?

Written by Shannon Wong on March 7, 2023

Have you ever wondered what is effective interest rate on loan or how it’s calculated?

The concept can be confusing for many borrowers. It could be especially for those who need to know why the advertised rate occasionally differs from their monthly payments.

If this article piques your curiosity, read on. It will help the next time you’re looking to get a loan. You will have adequate information on what is effective interest rate on loan.

What Is EIR?

The EIR meaning is the actual rate you pay on your loan instead of the advertised annual percentage rate (APR). It’s calculated by adding your monthly balance to the yearly payment, and then dividing that sum by 12 months.

The effective interest rate usually exceeds the advertised because you’re paying for both principal and interest simultaneously.

What Is EIR In Loan?

EIR is a term used to describe the total interest on a loan. It’s the amount you’ll pay to lenders over the life of your loan.

The EIR is calculated using information such as:

  • The loan amount
  • The interest rate per year; and
  • The number of years in which you’ll pay back the loan.

The Effective Interest Rate Is Also Called Apr (Annual Percentage Rate)

APR is the annual percentage rate that includes all fees and other costs associated with the loan. It’s calculated by taking your total borrowing cost and dividing it by your principal amount, then multiplying that figure by one hundred (100). The result is what you will pay in interest over a while.

Generally, loans with higher APRs are more expensive than the ones with lower APRs because lenders charge more when you borrow money from them. However, there are exceptions where some banks offer special rates for student loans or personal loans. In return, you’ll save money compared to similar products offered anywhere else across Singapore.

How To Calculate Effective Interest Rate

Many banks use the effective interest rate calculator Singapore while calculating the EIR. The EIR formula divides the total interest paid over the life of a loan by its principal amount. Consider using the following EIR calculator Singapore method:

Effective Interest Rate = (1 + CPI) x Loan Balance / [1 + (1/365) x Loan Balance]

Why Are Effective Interest Rates Typically Higher Than Advertised Rates?

What is effective interest rate on loan and why is it higher than advertised rates? Here are a few reasons:

  • The effective rate includes all costs associated with investing in bonds. These costs include interest, brokerage fees, and any other fees that may be associated with the account. Because of these fees, the actual rate paid on the bond will likely be lower than the advertised rate.
  • Knowing the difference between what is effective interest rate on loan and advertised rate helps you understand the yield curve spread. The concept refers to the difference between the lowest and highest yields on a bond or note. If there’s a wide gap between these two yields, then someone who buys at one end of the spectrum will pay more than they receive.
  • The difference between a low-grade corporate bond and a high-grade corporate bond can be quite large. The difference is significant if there’s no market for them in your portfolio or if you need cash quickly.

When this occurs, purchasing a so-called “junk” or “investment grade” bond makes sense.

  • To get a more accurate picture of how much you’ll pay on a particular loan, you’ll want to look at the effective annual percentage rate (EAR). It’s calculated by adding together all of the interest rates that apply to your loan or credit card balance over time.

How To Choose The Best Loan

Besides understanding what is effective interest rate on loan, it’s good to know how to pick the best loan type. Here are a few factors to consider when choosing a loan product from a bank in Singapore

  • Check if you need a loan: Start by asking yourself if you have enough money in your savings account to repay the loan fully and never have to repay it again. If not, consider getting a different loan (such as one with no interest)
  • Check the terms: Make sure all terms are clear before signing up for a loan. You should know precisely how much you need to pay each month or year. The information is essential when calculating what is effective interest rate on loan.

It’s also used to determine how much interest would be charged per year on your new mortgage/loan payments over its lifetime.

  • Get a lender: Choose an affordable and licensed money lender who offers competitive rates. A trustworthy lender doesn’t raise fees after accepting your application for approval.

What Is The Simple Interest Rate?

The simple interest rate is the interest charged on loan. It’s calculated by multiplying the principal by the interest rate and not considering any compounding. Simple interest rates are often used in car loans and credit cards because they’re easy to understand and provide guidelines for how much money you should pay back each month or year.

The formula for finding the simple interest rate is: [(1+r) n] n where r = annual percentage rate, n = number of months until maturity

Benefits Of Knowing What Is Effective Interest Rate On Loan

You must know what is effective interest rate on loan for better planning. Some benefits of having this information include:

  • It helps you in making decisions on whether or not to borrow money or not. If you have a good knowledge of this topic, then it will be easy to understand how much interest you should pay to settle the debt and avoid penalties.
  • You can plan your money better. You can calculate the amount of money you will have to pay back, which helps you save money in the long run.
  • Understanding what is effective interest rate on loan allows you to have a better understanding of how much you should borrow or spend, depending on your circumstances. If you know the amount of money you need to pay back the loan, then there’s no need for you to take on more debt than necessary.
  • It helps you determine your financial goals better. You can plan your finances so as not to exceed budget, which will help avoid financial problems later in life.
  • Knowing what is effective interest rate on loan helps you  calculate the down payment amount required for buying a house or other real estate property based on your income, debt ratio, and other factors that affect this calculation (e.g., down payment amount).

Should You Consider The Effective Interest Rate When Taking A Loan?

Understanding what is effective interest rate on loan can help you decide whether or not it makes sense to borrow money from a lender.

The effective monthly repayment amount is higher than the advertised monthly payment amount. The technique works best for those with sufficient savings or other assets to use as collateral for securing loans.

If you found this information helpful and would like to learn more, don’t hesitate to get in touch with 1AP Capital. It’s a trustworthy money lender in Singapore that offers the best advice about borrowing. It also offers you a variety of loan types, allowing you to choose the most appropriate for your needs.

Consider contacting 1AP Capital at any time for any questions you may have.

Apply for a loan now and enjoy a fast and 100% confidential process. All you need to do is provide your details, select the preferred loan type and click the “Apply Now” button.

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