EIR (Effective Interest Rate)

The Effective Interest Rate (EIR) is a metric that reveals the true cost of borrowing, accounting for not only the nominal interest rate but also any additional fees, charges, and the frequency of compounding. Like a compass guiding a traveler through a complex terrain, the EIR allows borrowers to navigate the intricate world of loans and make informed comparisons between different offers.

Example

Suppose a borrower is considering two loan offers with the same nominal interest rate of 5%. However, one loan has an annual compounding frequency, while the other compounds interest monthly. Using the EIR, the borrower can determine that the loan with monthly compounding has a slightly higher effective interest rate due to more frequent compounding, resulting in a higher overall cost of borrowing. By comparing the EIRs of different loans, borrowers can make more accurate assessments of the true costs associated with each option and choose the most suitable loan for their needs.