Calculate Your Effective Annual Rate (EAR) with this Easy Guide

How to calculate the effective annual rate (EAR) on a car loan with a nominal rate of 6.13 percent and interest charged monthly?

Options:

A. Divide the nominal rate by 12

B. Add 1 to the monthly interest rate, raise it to the power of 12, and subtract 1

The effective annual rate (EAR) on the car loan can be calculated by converting the nominal rate to an annual rate. The nominal rate is the stated interest rate on the loan, which in this case is 6.13 percent. To calculate the effective annual rate (EAR), we need to take into account the compounding effect of interest over the year.

One of the key components in this calculation is understanding how interest is charged. With the interest being charged monthly on the car loan, it is important to convert the nominal rate to a monthly rate to accurately determine the effective annual rate.

First, we need to convert the nominal rate to a monthly rate by dividing it by 12, as there are 12 months in a year. This step helps us calculate the monthly interest rate, which is essential for determining the effective annual rate.

Next, to find the effective annual rate (EAR), we need to add 1 to the monthly interest rate, raise it to the power of 12 (representing 12 months in a year), and then subtract 1 from the result. This formula takes into account the compounding effect of interest over the year and provides a more accurate reflection of the true annual interest rate on the loan.

By following this process, you can calculate the effective annual rate (EAR) on your car loan and gain a better understanding of the total interest you will pay over the course of a year. This approach helps in making informed financial decisions and managing your loan effectively.