How to calculate the effective real interest rate

[Eunice]

Hi Dennis,

In your book, you mentioned that car loan is charged on flat interest rate. The effective real interest rate is much higher.

May I know is there a "formula" or way which we can calculate the effective interest rate ourselves.

Thank you.

[star88]

I also not very sure how the bank calculate the interest rate. Recently my hubby just sold his 1 year old car. What I know is as below:-

Loan Amount: $32,000
Loan Period: 7 years
Interest Rate: 2.8%

$32,000 x 19.6% (total interest pay for 7 yrs) = $6,272 (total interest to bank)

$32,000 + $6,272 = $38,272 (total $ to bank for 7 yrs)

$38,272 / 84 months = $455.6 (monthly installment to bank for 7 yrs)

We own this car 1 yrs, so total we already pay to bank is $455.6 x 12 mths = $5,467.2

When we sold our car, the balance outstanding to bank is $29,500.

Luckly our car sold more than $30,000, so we do not need top up $.

[Dennis Ng]

Hi Dennis,

In your book, you mentioned that car loan is charged on flat interest rate. The effective real interest rate is much higher.

May I know is there a "formula" or way which we can calculate the effective interest rate ourselves.

Thank you.

Hi Eunice,
Banks/Finance companies show Car Loan on flat rate basis.

eg. 3% interest rate on Car Loan of S$50,000 for 7 years.

means interest = 3% x $50,000 x 7 years, divided by 84 months to arrive at monthly instalment.

Thus, from above calculations, you can see that the Interest charged on the Car Loan is the same on the 1st month and even in the last month when you have paid off 83 months of instalments.

While Effective Interest rate is calculated based on a Reducing Balance basis. eg. Housing Loan, whereby interest is charged on the Loan outstanding at any point in time and not the original loan amount.

Hope this clarifies.