In: Finance
Suppose you are considering taking consumer loan from bank for one year. Usually, for short- term loans, the bank offers 8 percent interest that compounds annually. Your credit application has been viewed by a few banks and two of them replied; Bank ALFA offers you a loan at 8 percent annual rate-interest payment by the end of year, and Bank BETA offers a loan with the same annual interest rate, but interest payment is 2 percent by the end of each quarter. Which loan do you prefer? Why?
EAR for Bank Alpha = 8%
EAR for Bank Beta
EAR = (1 + APR / m) ^ m -1 |
EAR = (1 + 8% / 4) ^ 4 -1 |
EAR = 8.24% |
As per above calculations we can see that in case of Bank Beta you will end up paying higher effective annual rate (EAR) which is 8.24%. So as you are at borrowing side you will prefer to pay less EAR hence you will chose bank Alpha.