Can anyone explain “simple interest rate” vs “effective interest rate”?
For loans with fixed term e.g. car loans.
In: Economics
Simple: for example, you bullet-lend someone €100 @ 2% interest. Bullet loan means there’s no interim repayment obligation. Your return is €2 in the first year, €2 in the second year, etc.
Effective: same example, but the interest compounds, so in year one your return is €2, but it’s €2*(100%+2%), so €2.04 in year two. In year three it’s €2.04*(100%+2%), etc.
It’s basically the difference between compounded and ‘single’ interest.
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