loan is £5000, flat interest rate is 10%, and repaid at the end of each of the next of 12 months explain why the effective annual interest rate is roughly twice that flat rate of interest? i understand why effective annual interest rate is higher than flat rate of interest, but why its twice, and the explaination in the material mentioned average amount borrowed,£2500, is it something to do with statistics again??? and finally it used total interest payments divided by the average loan outstanding 500/2500=20%. and why the average amount borrowed is the average loan outstanding ?? confusing ....
If you borrow 5000, and repay it fairly evenly over the year, so that you don't owe anything at the end of the year, then over the course of the year will be be borrowing roughly 2,500, on average (5000 + 0) / 2. "Loan outstanding" is just another way of saying "amount borrowed" or "amount you owe" at any point in time. So averahe amount borrowed = average amount outstanding. So in this case we're paying 500 interest on a loan of 2500 on average. Hence true interest rate is around 20%.
