Effective annual interest rate with compensating balance
The Effective Annual Rate (EAR) is the interest rate that is adjusted for compounding over a given period. Simply put, the effective annual interest rate is the rate of interest that an investor can earn (or pay) in a year after taking into consideration compounding. Company X has a line of credit at Bank A that requires it to pay 11% interest on its borrowing and to maintain a compensating balance equal to 15% of the amount borrowed. The company has borrowed $800,000 during the year under the agreement. Effective rate compensating balance = 6%/(1 - 0.2) = 7.5 percent (if c is a 20 percent compensating balance) Effective Interest Rate on Installment Loans Many consumers have installment loans, which are loans that are repaid with a set number of payments. The effective interest rate is: $ 1,200 / $ 9,000 or 13.3%. Compensating balances also decrease the proceeds of the loan. As proceeds decline, the effective interest rate rises. Example: You borrow $ 30,000 at 12%. The Bank requires that you maintain a 10% compensating balance. The effective interest rate is: $ 3,600 / ($ 30,000 - $ 3,000) = 13.3%. With 10%, the continuously compounded effective annual interest rate is 10.517%. The continuous rate is calculated by raising the number "e" (approximately equal to 2.71828) to the power of the interest rate and subtracting one. It this example, it would be 2.171828 ^ (0.1) - 1. Trying to calculate effective interest rate on loan with the following terms: 128 day term loan; 5.4% interest rate; 12% compensating balance required; Stuck by idea of compensating balance and how to factor that into the math. To determine the rate on a fee added loan you just add the fees as a percentage of the principle to the interest. This is because in a fee added loan, the fees are considered a part of the interest. So a compensating loan with an 8 percent rate and 20% compensating balance has an effective rate of 10%
Calculating effective interest rate is actually a rather complicated process. You need to take into account interest rate based on reduced balance of your loan,
Compensating Balances. Finance - EPS and EBIT; Discount Loan / Compensating Balance Computing The Effective Annual Interest Rate on Loans Effective annual rate Effective annual percentage rate of forgoing cash discount Lockbox, relaxing credit standards, effective annual rate Finance Problems: Credit, Zero-Balance Account, and Annual Rate A compensating balance is a minimum bank account balance that a borrower agrees to maintain with a lender.The purpose of this balance is to reduce the lending cost for the lender, since the lender can invest the cash located in the compensating bank account and keep some or all of the proceeds. What is the effective annual interest rate for a one-year $100 million loan with a stated interest rate of 8.00%, if the lending bank requires a non-interest bearing compensating balance in the amount of $5 million? The effective annual interest rate associated with this loan is _____? Compensating Balance: When a loan has a compensating balance, the borrower must keep a fraction of the amount borrowed at a Effective Annual Rate (I) is the effective annual interest rate, or "effective rate". In the formula, i = I/100. Effective Annual Rate Calculation: Suppose you are comparing loans from 2 different financial institutions. The first offers you 7.24% compounded quarterly while the second offers you a lower rate of 7.18% but compounds interest weekly. Holland Construction Co. has an outstanding 180-day bank loan of $400.000 at an annual interest rate of 9.5%. The company is required to maintain a 15% compensating balance in its checking account. What is the effective interest rate on the loan? Assume the company would not normally maintain this average amount. Commonly the effective interest rate is in terms of yearly periods and stated such as the effective annual rate, effective annual interest rate, annual equivalent rate (AER), or annual percentage yield (APY), however, the formula is in terms of periods which can be any time unit you want.
27 Apr 2012 7-6Knight Roundtable Co. has annual credit sales of$1,080,000 and an average collection period What is the effective rate of interest if the loan is discounted? Discounted interest with a 5 percent compensating balance.
Such a deposit is called a compensating balance that is usually presented as a percentage of the loan. If a compensating balance is placed on the unused portion of the line of credit, the interest rate will be smaller. To calculate the effective annual interest rate on a line of credit, the following formula can be used: So here's how to calculate the "effective" annual rate in each case: - No deposit In this case you keep the full $800,000, and pay $88,000 a year. Therefore, the annual rate is clearly 11%. - Mantain $70,000 The actual amount you borrow here is $730,000, on which you pay $88,000 a year. Therefore, the interest rate is 88000/730000=0.1205.
Holland Construction Co. has an outstanding 180-day bank loan of $400.000 at an annual interest rate of 9.5%. The company is required to maintain a 15% compensating balance in its checking account. What is the effective interest rate on the loan? Assume the company would not normally maintain this average amount.
The effective interest rate of a compensating balance installment loan is higher than a regular loan because you must tie up a portion of your loan as the 6 Dec 2019 However, the effective interest rate on a loan with a compensating balance is actually higher than a balance-free loan. Types of Lending. In most Your annual percentage rate or APR is the same as the stated rate in this example because there is no Effective Interest Rate With Compensating Balances. 15 Jul 2019 The compensating balance is generally a percentage of the loan. Assume, for example, the interest rate on the LOC is an annual rate of 6% 27 Oct 2011 Introduction to effective annual interest rate in context of loans. The effective When a loan requires a compensating balance: Proceeds Trying to calculate effective interest rate on loan with the following terms: 128 day term loan; 5.4% interest rate; 12% compensating balance required. Stuck by idea 5 May 2017 However, the borrower is also paying interest on a net loan balance that is smaller than the amount of the loan, so the effective interest rate for
We should take into account the following factors when calculating the effective interest rate: Extra fees. They are hidden interest expense by their nature. Terms and conditions affecting the amount of usable funds. For example, the compensating balance requirement reduces the amount of usable funds.
An interest rate is the amount of interest due per period, as a proportion of the amount lent, Annual percentage rate (APR) and effective annual rate or annual equivalent rate (AER) are used to help a bank for 1 year, and they receive interest of $10 (before tax), so at the end of the year, their balance is $110 (before tax). The effective interest rate of a compensating balance installment loan is higher than a regular loan because you must tie up a portion of your loan as the 6 Dec 2019 However, the effective interest rate on a loan with a compensating balance is actually higher than a balance-free loan. Types of Lending. In most
Generally, the longer the term of the loan, the higher the interest rate. Tip A compensating balance is negotiable and some banks simply request an informal and annual financial statements (your balance sheet and income statement) and 27 Apr 2012 7-6Knight Roundtable Co. has annual credit sales of$1,080,000 and an average collection period What is the effective rate of interest if the loan is discounted? Discounted interest with a 5 percent compensating balance. ing—method for calculating the interest rate required or a compensating balance. As used every month, the effective annual rate is not 36% (12 x .03), but. 18 Mar 2019 $10,000 0.10Effective interest 14.29% [$10,000 (1 0.10 0.20)]. × = = × − −. P15- 10. LG 3: Compensating Balances and Effective Annual Rates Divide the nominal interest due by the available principal to calculate the effective interest rate of your compensatory balance installment loan. Example: Assume the interest rate on a compensatory balance loan has an interest rate of 5 percent, a principal of $100,000, and a compensatory balance of $5,000. Borrowing $150,000 at 6% simple interest over one year yields $9,000 in interest over the life of the loan. However, the effective interest rate on a loan with a compensating balance is actually higher. You're paying $9,000, but after you subtract the $25,000, you're paying the interest on only $125,000.