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    Bank Loan Interest Calculator

    Uploaded by

    godabari
    This document discusses different methods that banks use to calculate interest rates on loans and how they affect the effective interest rate. It provides examples of calculating the effective interest rate on simple interest loans, loans with terms less than one year, discounted loans, loans with compensating balances, and installment loans. The key points are that banks quote an effective annual percentage rate (APR) that may differ from the stated rate due to factors like loan term, payment schedule, and required balances; understanding these calculations helps borrowers know what they will actually pay in interest.

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    Attribution Non-Commercial (BY-NC)
    Download as DOCX, PDF, TXT or read online from Scribd

    Bank Loan Interest Calculator

    Uploaded by

    godabari
    104 views2 pages
    This document discusses different methods that banks use to calculate interest rates on loans and how they affect the effective interest rate. It provides examples of calculating the effective interest rate on simple interest loans, loans with terms less than one year, discounted loans, loans with compensating balances, and installment loans. The key points are that banks quote an effective annual percentage rate (APR) that may differ from the stated rate due to factors like loan term, payment schedule, and required balances; understanding these calculations helps borrowers know what they will actually pay in interest.

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    This document discusses different methods that banks use to calculate interest rates on loans and how they affect the effective interest rate. It provides examples of calculating the effective interest rate on simple interest loans, loans with terms less than one year, discounted loans, loans with compensating balances, and installment loans. The key points are that banks quote an effective annual percentage rate (APR) that may differ from the stated rate due to factors like loan term, payment schedule, and required balances; understanding these calculations helps borrowers know what they will actually pay in interest.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    104 views2 pages

    Bank Loan Interest Calculator

    Uploaded by

    godabari
    This document discusses different methods that banks use to calculate interest rates on loans and how they affect the effective interest rate. It provides examples of calculating the effective interest rate on simple interest loans, loans with terms less than one year, discounted loans, loans with compensating balances, and installment loans. The key points are that banks quote an effective annual percentage rate (APR) that may differ from the stated rate due to factors like loan term, payment schedule, and required balances; understanding these calculations helps borrowers know what they will actually pay in interest.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
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    Before you take out a bank loan, you need to know how your interest rate is calculated.

    There are
    many methods banks use to calculate interest rates and each method will change the amount of
    interest you pay. If you know how to calculate interest rates, you will better understand your loan
    contract with your bank. You are also in a better position to negotiate your interest rate with your
    bank. Banks will quote you the effective rate of interest. The effective rate of interest is also
    known as the annual percentage rate (APR). The APR or effective rate of interest is different than
    the stated rate of interest.
    Effective Interest Rate on a one Year Loan

    If you borrow $1000 from a bank for one year and have to pay $60 in interest for that year, your
    stated interest rate is 6%. Here is the calculation:

    Effective Rate on a Simple Interest Loan = Interest/Principal = $60/$1000 = 6%

    Your annual percentage rate or APR is the same as the stated rate in this example because there is
    no compound interest to consider. This is a simple interest loan.

    Effective Interest Rate on a Loan With a Term of Less Than one Year

    If you borrow $1000 from a bank for 120 days and the interest rate is 6%, what is the effective
    interest rate?

    Effective rate = Interest/Principal X Days in the Year (360)/Days Loan is Outstanding

    Effective rate on a Loan with a Term of Less Than one Year=$60/$1000 X 360/120 =
    18%

    The effective rate of interest is 18% since you only have use of the funds for 120 days instead of
    360 days.

    Effective Interest Rate on a Discounted Loan

    Some banks offer discounted loans. Discounted loans are loans that have the interest payment
    subtracted from the principal before the loan is disbursed.

    Effective rate on a discounted loan = Interest/Principal - Interest X Days in the Year (360)/Days
    Loan is Outstanding

    Effective rate on a discounted loan=$60/$1,000 - $60 X 360/360 = 6.38%

    As you can see, the effective rate of interest is higher on a discounted loan than on a simple
    interest loan.

    Effective Interest Rate with Compensating Balances

    Some banks require that the small business firm applying for a business bank loan hold a balance,
    called a compensating balance, with their bank before they will approve a loan. This requirement
    makes the effective rate of interest higher.

    Effective rate with compensating balances (c) = Interest/(1-c)

    Effective rate compensating balance= 6%/(1 - 0.2) = 7.5% (if c is a 20% compensating
    balance)

    Effective Interest Rate on Installment Loans


    One of the most confusing interest rates that you will hear quoted on a bank loan is that on an
    installment loan. Installment loan interest rates are generally the highest interest rates you will
    encounter. Using the example from above:

    Effective rate on installment loan = 2 X Annual # of payments X Interest/(Total no. of payments +


    1) X Principal

    Effective rate/installment loan=2 X 12 X $60/13 X $1,000 = 11.08%

    The interest rate on this installment loan is 11.08% as compared to 7.5% on the loan with
    compensating balances.

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