How Are Effective Interest Rates Calculated?

The effective interest rate, sometimes called effective rate or effective annual interest rate is basically the term used to describe an interest rate levied on a loan or financial service which is repeated from the nominal interest rate in the form of an interest rate along with annual compound interest.

As an interest rate may be described by making use of various compounding terms, the yearly cost of interest between two distinct loans may not be liable for comparison. Thus the effective interest rate is made use of to make these kinds of loans more conducive for comparison by transforming any loan into the corresponding annual rate.

Effective interest rate is calculated as if compounded on a yearly basis. It is calculated in the given way: r = (1 + i/n) to the power of n -1. Wherein r = effective annual rate, i = nominal rate
n = number of compounding periods on an annual basis

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