1. What is Effective Annual Rate (EAR)?

The Effective Annual Rate (EAR) is the actual interest rate that accounts for compounding periods and additional costs like points. It provides a true comparison between different loan options by showing the real annual cost of borrowing.

2. How Does the Calculator Work?

The calculator uses the EAR formula with points:

Where:

• \( i \) — Nominal interest rate (in decimal)
• \( points \) — Points paid (1 point = 1% of loan amount)
• \( term \) — Loan term in years
• \( n \) — Number of compounding periods per year

Explanation: The equation adjusts the nominal rate by adding the annualized cost of points (points divided by loan term) and then accounts for compounding effects.

3. Importance of EAR Calculation

Details: EAR provides a standardized way to compare loans with different rates, points, and compounding frequencies. It's particularly important when evaluating mortgage options where points are involved.

4. Using the Calculator

Tips: Enter the nominal rate as a percentage (e.g., 4.5 for 4.5%), points as whole numbers (e.g., 1 for 1 point), loan term in years, and compounding periods per year (12 for monthly).

5. Frequently Asked Questions (FAQ)

Q1: What are points in a loan?
A: Points are upfront fees paid to reduce the interest rate, where 1 point equals 1% of the loan amount.

Q2: How does compounding affect EAR?
A: More frequent compounding increases EAR for a given nominal rate. Monthly compounding (n=12) results in higher EAR than annual compounding (n=1).

Q3: Should I pay points on my loan?
A: It depends on how long you plan to keep the loan. The calculator helps compare options by showing the true cost of points.

Q4: What's the difference between APR and EAR?
A: APR includes fees but assumes simple interest, while EAR accounts for compounding effects.

Q5: How accurate is this calculation?
A: This provides a good estimate, but actual loan costs may vary slightly due to payment timing and other factors.