1. What is the Effective Cost Of Borrowing?

The Effective Cost of Borrowing represents the true annual cost of a loan when compounding is taken into account. It's higher than the nominal rate due to the effect of compounding interest more frequently than annually.

2. How Does the Calculator Work?

The calculator uses the Effective Cost formula:

Where:

• Nominal Rate — Stated annual interest rate (in decimal form)
• Periods — Number of compounding periods per year

Explanation: The formula calculates the actual annual percentage rate when interest compounds more frequently than once per year.

3. Importance of Effective Cost Calculation

Details: Understanding the effective cost of borrowing helps consumers compare different loan offers accurately and make informed financial decisions about credit products.

4. Using the Calculator

Tips: Enter the nominal interest rate as a decimal (e.g., 0.05 for 5%) and the number of compounding periods per year. Both values must be valid (nominal rate ≥ 0, periods ≥ 1).

5. Frequently Asked Questions (FAQ)

Q1: Why is effective cost higher than nominal rate?
A: Effective cost accounts for compounding, which means you pay interest on previously accrued interest, increasing the total cost.

Q2: How does compounding frequency affect effective cost?
A: More frequent compounding (higher periods value) results in a higher effective cost, as interest is calculated and added more often.

Q3: What's the difference between APR and effective rate?
A: APR is typically the nominal rate, while the effective rate includes compounding effects and represents the true annual cost.

Q4: When is effective cost most important to consider?
A: When comparing loans with different compounding frequencies or when evaluating credit cards, mortgages, and other loans that compound interest.

Q5: Can effective cost be lower than nominal rate?
A: No, effective cost is always equal to or greater than the nominal rate due to the compounding effect.