# Effective Interest Rate

The effective interest rate is an 'interesting' as well as important way of calculating the actual interest that you would be paying on a loan. In this article, we will look at this concept which you should know as a consumer.

Arjun Kulkarni

Method

To start off with, there's one very important thing that you need to understand about compound interest. When we calculate compound interest, we take into consideration the starting amount of principal, the interest rate, and the number of periods for which the amount will be compounded. Most often, the number of periods will be the number of years, which means that the principal will be compounded every year.

Calculation

Because the monthly and weekly compounding can be a little misleading, this method can help you ascertain how much interest you would effectively be paying for the year. The formula mentioned below calculates the effective rate:

where i = nominal rate

*Effective Interest Rate = (1 +*^{i}/_{n})^{n}- 1where i = nominal rate

*and*n = number of compounding periods per year.