When you are going to borrow money, you obviously want to know what the loan will cost you. With the help of effective interest rate you can quickly find out how much a loan will cost you in the end. This makes it easier for you to compare different offers and get the most advantageous loan.
What is effective interest rate?
When you borrow money from a bank, you usually pay the interest monthly. The interest rates that banks and lenders usually emphasize in advertising mail are almost always nominal interest rates. The nominal interest rate is the cost of the loan without hidden fees such as avi fees, setup fee and interest-on-interest effect. Since the fees often differ between different banks and lenders, you should never compare loans using only the nominal interest rate. Hidden fees can be very high, which means that loans that appear to be cheap are really very expensive.
To make it easier to quickly get an overview of the total cost of the loan, lenders must also state the effective interest rate according to the Consumer Credit Act. Based on this, it is possible to calculate the total cost of the loan, including nominal interest and fees. This makes it easier for you to compare the current cost of the loans that different lenders offer you. The effective interest rate thus reflects the total cost of the loan.
Calculating the effective interest rate on your own can be cumbersome. The important thing to remember when thinking about borrowing money and wanting to find the best loan is that lenders must present effective interest somewhere in connection with their advertising. Sometimes it is difficult to find where the effective interest rate is stated, but it usually hides in the fine print. Therefore, always be sure to check the effective interest rate and use it when comparing different loans.
How to calculate effective interest rate?
It is a more complicated calculation than many people think. According to the Consumer Agency, lenders should do this according to the following model:
The formula that few can interpret and even fewer actually figure out. But that’s why comparator exists. Our experienced advisers have nothing but economics and mathematics in mind. Do not want anything but that you just want to get the best possible loan with the lowest possible effective interest rate.
How do setup and notification fees work?
The setup fee is the fee that the lender charges to start up the loan and is to cover the lender’s administrative costs for the arrangement. The notification fee, or the avi fee as it is often shortened, takes the lender to send out an invoice. Thus, if you pay the loan monthly, there will be an avi fee per month.
The fee is usually added when you have chosen to receive a paper invoice, but in many cases the lender charges an administrative fee even if you pay via e-invoice or by direct debit. It is common to miss this when trying to compare car loans, as the bank sometimes fails to include the fees, which in the end makes the loan more expensive (has a higher effective interest rate) than first stated.
Is the effective interest rate higher for certain types of loans?
Sometimes you see advertising for interest-free loans, free loans and interest-free installments. It sounds amazingly good. But – it sounds too good to be true – it is often just not.
A typical example is SMS loans. They often have a period – between 30-90 days – with no interest and sometimes no fees at all. But if you choose to extend the loan or are late with the payment then there is a high interest rate and / or high delay fees. Therefore, the nominal interest rate can be zero, while the effective interest rate is extremely high, several 100 or 1000 percent.
So if you focus solely on the nominal interest rate, and do not take into account the fees that may apply, you risk that the loan will be much more expensive than you had intended. The effective interest rate is therefore important to include in the calculations and a good tool when comparing bank rates.
Loan comparator helps you reduce your loan costs
It can be difficult to calculate interest on loans without any kind of help. Therefore, we have developed our loan calculator where you fill in the nominal interest rate and fees and can thus make your own loan calculation.
You can also contact us directly. Our advisors compile the effective interest rate for all your loans and calculate your total cost. Then we can compare how your loan situation changes for the better if you take the best loan offer from one of our partner banks.