## Calculating the interest on a loan

If a loan is taken out, for example to finance a property or a car, the bank will charge interest. The interest is the cost of the loan in addition to the repayment. They indicate how expensive a loan is. There are two different interest rates that are important. The effective interest rate and the target or nominal interest rate.

The debit or nominal interest rate determines the additional costs incurred for borrowing the money. The effective interest rate takes other costs such as processing fees, etc. into account. It determines the total cost of the loan.

### The target or nominal interest rate

This interest rate is used to calculate the interest on the loan. The basis for the calculation is the net loan amount. This interest rate is contractually agreed as a percentage and relates to a full calendar year. It is generally fixed for ten years.

The interest rate is determined by the current market interest rate. It should be noted that this interest rate does not describe the full costs. It is therefore not suitable for comparing different loans.

### The effective interest rate

This interest rate includes all costs incurred. These include administration fees, commitment fees and processing fees. In addition, brokerage costs may be incurred, which are charged via the effective interest rate.

This interest rate is also given as a percentage. It is a good way of comparing different loan offers. Lenders are obliged to inform the borrower of the interest rate. They must also disclose the calculation.

## The calculation of interest rates

An example calculation: A used car is to be financed with a loan. The purchase price is €6,000. The bank's offer is financing over 48 months, with an interest rate of 4.50 percent. There are no additional costs such as processing fees.

**The effective annual interest rate is calculated as follows:**

**Formula**: (interest costs * 100) / (loan amount * term in years) = effective annual interest rate (in %)

**Example**: (1,080 euros * 100) / (6,000 euros * 4) = 4.50 % p.a.

This calculation of the annual percentage rate of charge is very simplified. Banks calculate this interest rate in a much more complicated way. They also take into account the time lag between payments. The APR is therefore slightly higher than the borrowing rate.

**Calculating the borrowing rate or nominal interest rate (interest costs)**

**Formula**: Loan amount * borrowing rate * term = interest costs

**Example**: 6,000 euros * 4.50 % * 4 = 1,080 euros

(The calculation with decimal places: 6,000 * 0.045 * 4)