You take out a 2-year, 5,000 loan at 9 % simple annual...

You take out a 2-year, $\$ 5,000$ loan at $9 \%$ simple annual interest. The lender charges you a $\$ 100$ fee. Thinking of the fee as additional interest, what is the actual annual interest rate you will pay?

Key Concepts

Simple Interest

Simple interest is a method of calculating the interest charge on a loan where the interest is computed only on the original principal, rather than on the accumulated interest from previous periods. This means the interest expense remains constant for each period, which makes it straightforward to calculate for loans with fixed terms and rates.

Effective Annual Interest Rate

The effective annual interest rate accounts not only for the nominal interest rate applied to the principal but also includes any additional fees or costs that increase the total borrowing expense. By converting all charges into an annual percentage, it provides a more accurate picture of the real cost of borrowing over the life of the loan.

Loan Fees as Additional Cost

Loan fees, even if they are not part of the stated interest rate, contribute to the overall cost of borrowing. When these fees are treated as additional interest, they effectively raise the amount of interest you end up paying on the loan. This perspective helps in comparing loans on a like-for-like basis when fees vary across different lenders.

Total Cost of Borrowing

The total cost of borrowing includes both the interest accrued over the lifetime of the loan and any additional fees or charges imposed by the lender. Evaluating this total cost is crucial for understanding the real expense of a loan, as it allows borrowers to assess the true financial impact and compare different loan offers more effectively.

Transcript

Please give Ace some feedback