Question

Drew, the owner of a local Home Hardware is in the need of some quick cash. He went to a friend that recently won the lottery and the financing proposal the friend offered was: $15,000, 9 month bank loan with interest at 6%, and a lender’s fee of $500 due at the end of the loan. What is the effective interest rate of this loan? Round your answer to 2 (two decimals). For example: 10.05%.

Answer 1

Here Finance Charges includes 2 things

1) Interest Component = $15,000 * 6% = $900 (here not given 6% annually, hence it is flat 6% on $15,000)

2) Lender's fees = $500

Total Finance Charges = $900 + $500 = $1400 Payable after 9 month with principle amount

Now to Find Effective rate we will use normal Interest calculation Formula

Finance Charges = Loan Amount * interest rate * Period of Holding

$1400 = $15000 * Interest Rate * 9 month / 12 month (as we want rate annually)

therefore

Interest rate = $1,400 * 12 / $15,000 * 9

Interest Rate = 12.44% p.a.OR 9.33% Flat for 9 months

( Verification :

Interest @ 12.44% on amount of $15,000 for 9 month = $15,000 * 12.44% * 9/12 = $1,400 )

Therefore effective Interest rate for the loan = 12.44% p.a. OR 9.33% Flat for 9 months

Note

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