1. What is the Effective Interest Rate?

The Effective Interest Rate (EIR) is the actual interest rate that an investor earns or a borrower pays in a year after accounting for the effects of compounding. It provides a true comparison between financial products with different compounding periods.

2. How Does the Calculator Work?

The calculator uses the Effective Interest Rate formula:

Where:

• \( EIR \) — Effective interest rate (decimal)
• \( i \) — Nominal interest rate (decimal)
• \( n \) — Number of compounding periods per year (unitless)

Explanation: The formula accounts for how frequently interest is compounded, showing the true annual cost or return of a financial product.

3. Importance of EIR Calculation

Details: EIR is crucial for comparing loans or investments with different compounding frequencies. It helps consumers make informed financial decisions by showing the true cost or return.

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 (e.g., 12 for monthly compounding).

5. Frequently Asked Questions (FAQ)

Q1: What's the difference between nominal and effective rate?
A: Nominal rate doesn't account for compounding, while effective rate does. For products with annual compounding, they're the same.

Q2: How does compounding frequency affect EIR?
A: More frequent compounding (e.g., daily vs. monthly) results in a higher EIR for the same nominal rate.

Q3: When is EIR most important to consider?
A: When comparing financial products with different compounding periods or when compounding occurs more frequently than annually.

Q4: Can EIR be lower than nominal rate?
A: No, EIR is always equal to or greater than the nominal rate when compounding occurs.

Q5: How do I convert percentage to decimal for input?
A: Divide the percentage by 100 (e.g., 5% becomes 0.05).