The interest rate is often less than the effective interest rate. It seems that the loan is cheap, but if you take into account all the overpayments, it turns out that it will cost the company dearly. Let’s look at this in more detail.
The interest rate is the percentage charged for using money; loan interest. The interest rate does not include other payments: insurance, commissions, fees.
The effective rate is the actual cost of the loan. The effective rate includes interest on the loan, commissions, insurance and additional payments and fees. That is, this is the amount that the borrower will ultimately pay.
Let’s look at an example of a mistake in choosing a loan. Let’s say an entrepreneur is offered a loan at 10% per annum. But the conditions stipulate that if a company is not serviced by a bank, then the rate for it will be 11%. And then there are commissions for replenishing your account and fees – let’s say another 2%. It turns out already 13% – this will be the effective rate; actual overpayment on the loan.
In total, instead of the expected 10% per annum, it turns out to be 13%. A 3% “premium” is the best option, sometimes the effective rate can be as high as 40-45% per year. Therefore, before applying for a loan, you need to carefully read the terms of the contract and calculate the actual overpayment.
