You have just taken out a loan for $75,000. The stated (simple) interest rate on this loan is 10 percent, and the bank requires you to maintain a compensating balance equal to 15 percent of the initial face amount of the loan. You currently have $20,000 in your checking account, and you plan to maintain this balance. The loan is an add-on installment loan which you will repay in 12 equal monthly installments, beginning at the end of the first month.
-XYZ Company needs to borrow $200,000 from its bank. The bank has offered the company a 12-month installment loan (monthly payments) with 9 percent add-on interest. What is the effective annual rate (EAR) of this loan?

Question

Quizplus · Accepted Answer

The effective annual rate (EAR) for an add-on interest loan can be calculated by considering the total interest paid over the loan term and the actual amount of funds available for use. The EAR accounts for the fact that the borrower does not have access to the full loan amount due to the compensating balance requirement.

You Have Just Taken Out a Loan for $75,000