Effective rate

Definition

A term used in two ways.

In one context it refers to a measure of interest cost to the borrower that is identical to the APR except that it is calculated over the time horizon specified by the borrower.

The APR is calculated on the assumption that the loan runs to term, which most loans do not.

In most texts on the mathematics of finance, however, the "effective rate" is the quoted rate adjusted for intra-year compounding.

For example, a quoted 6% mortgage rate is actually a rate of .5% per month, and if interest received in the early months is invested for the balance of the year at .5%, it results in a return of

6 >> 17% over the year.

The

6 >> 17% is called the "effective rate" and 6% is the "nominal" rate.

Related Terms

Other terms related to 'Effective rate' starting with the letter 'E'

Equity, Escrow, Equity grabbing

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