Interest Rate Vs. Effective Rate. What is the Difference?

Interest Rate Vs. Effective Rate

The finance world is, unfortunately, riddled with grey area. Having an understanding of the difference between an interest rate and the effective rate can, in some instances, save you thousands over the lifetime of a loan. Let us break it down.

Interest Rate

The interest rate of a loan is the base rate that the finance broker has access to. One thing to note, finance brokers may have access to cheaper base rates than going directly to a bank/lender due to the volume of loans they do. However, the interest rate does not include the fees attached to the loan, these may include: brokerage amount, document fees (if financed into the contract etc).

Effective Rate

The effective rate of a loan is the rate which the repayment amount is based off. The effective rate is inclusive of brokerage amount, document fees (if chosen to be financed in contract). Think of the effective rate as the rate you are actually paying.

Here is where things start to get tricky… If a customer asks what the interest rate of the loan is, a finance broker can simply say the base rate they have access to, leading the customer to believe that is what their repayments are based off. However, this is definitely not the case. Below is a short case study of how we managed to inform and ultimately save one of our clients’ money.

Our client, Geoff, was in an exciting position of purchasing new equipment, a skid steer and trailer, for his business. He had been quoted a rate of 3.99% for both pieces of equipment. After Geoff forwarded the original finance quote for a second opinion, it became very clear to our lending specialists that the repayment amounts of $485.00 and $144.00 per month were in fact a lot higher for a rate of 3.99%. After analysing the quote, the actual effective rate for each piece of equipment came out to 6.57% and 13.34%. Once we informed Geoff this was the situation, we secured an effective rate for both pieces of equipment at 4.9%. This equates to a saving of ~$2,400 over the lifetime of the loan.

Here is what Geoff had to say about his experience with the Matias Group…

“The experience was excellent. I received excellent service and great advice. When I found out what the actual interest rate was, I felt ripped off. It was well worth taking the time to be advised properly and get the effective rate, so I wasn’t ripped off. It was really nice to not be treated as a number and work with someone who has my best interests at heart.”

Geoff H.

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