Ms. Smith borrowed $2,000 at an 8% stated rate of interest and was to pay back the loan in 24 monthly payments. What is her effective rate of interest using the installment loan formula?
A) 10.5%
B) 15.4%
C) 18.9%
D) 22.0%

Question

Quizplus · Accepted Answer

The effective rate of interest on an installment loan is higher than the stated rate due to the way interest is compounded and the fact that payments are made over time, reducing the principal. The installment loan formula or calculations would show that the effective rate of interest for Ms. Smith's loan is 15.4%. This accounts for the interest paid over the life of the loan in relation to the original loan amount, considering the decreasing balance as payments are made.

Ms Smith Borrowed $2,000 at an 8% Stated Rate of Interest