Effective Interest Rate

by Ed

Last week, we discussed about compounding interest and also how to use the rule of 72 to estimate the rate at which your money doubles. This forms the foundation on our next topic, which is, the difference between nominal interest rate and effective interest rate.

Most financial institution quote nominal interest rate. This is usually lower than the effective interest rate due to how frequent the interest is compounded. Many people are paying a lot more interest than they think they are, because of this difference.

Here is a thorough explanation of effective interest rate and also an example to show how big a difference it can be.

Compound Interest

Rule of 72

Time Value of Money