How to calculate effective interest rate

Effective interest rate calculation.

Effective period interest rate calculation

The effective period interest rate is equal to the nominal annual interest rate divided by the number of periods per year n:

Effective Period Rate = Nominal Annual Rate / n

Example

What is the effective period interest rate for nominal annual interest rate of 5% compounded monthly?

Solution:

Effective Period Rate = 5% / 12months = 0.05 / 12 = 0.4167%

Effective annual interest rate calculation

The effective annual interest rate is equal to 1 plus the nominal interest rate in percent divided by the number of compounding persiods per year n, to the power of n, minus 1.

Effective Rate = (1 + Nominal Rate / n)n - 1

Example

What is the effective annual interest rate for nominal annual interest rate of 5% compounded monthly?

Solution:

Effective Rate = (1 + 5% / 12)12 - 1

      = (1 + 0.05 / 12)12 - 1

      = 0.05116 = 5.116%

 

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