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Debit Interest and Effective Interest: Important Differences You Should Know!

Debit interest and effective interest

If you have ever planned to take out a loan, you have certainly come across the terms debit interest and the effective interest rate . But do you also know what the effective borrowing rate or the effective annual interest rate mean? What do the percentages say about the loan amount and what should you pay attention to when comparing loans? The two terms are explained in more detail below, but illustrative examples and the pitfalls are also presented. So you know exactly which loan for you is best and whether even a credit remortgage worth.

The expensive difference between borrowing and effective interest

When you take out a loan , you usually accrue interest. There are also loans with negative interest rates , but this should be viewed more as a PR campaign. This borrowing interest accrues over the entire term of the loan and it determines the amount that must ultimately be repaid. To understand the effective interest rate, one has to go back to 2014. This year, lawmakers banned banks from charging processing fees for loans. But the institutes quickly found a back door in the form of interest. An APR includes additional fees that would otherwise not have been incurred, replacing processing fees and other fees. As a result, the effective interest rate is the gross value of a loan, so to speak .

You should also consider the APR when comparing loans

If you now add up the loan amount and both interest rates, then the complete amount due comes out that must be repaid. Both interest rates play a role in a loan comparison. However, it makes little sense to choose a loan based on the borrowing interest. Since an APR is due on almost all loans, it is worthwhile to include the effective interest rate in the comparison in order to be able to determine the real cost of the loan.

Calculation examples for the debit interest and the effective interest

The following examples are intended to illustrate the differences between the debit interest and the effective interest in a brief form:

  1. Max Mustermann borrowed 1,000 euros at an interest rate of six percent. He pays back the sum of 1060.00 euros within one year. As a result, the borrowing rate and the effective rate are identical.
  2. The debit interest only reflects the pure interest costs, while the effective interest rate also includes additional fees and costs. You borrow 1000 euros from the bank and pay back 1050 euros at the end of the term. The bank charges a fee of 10 euros and collects this directly when you pay out. So you would receive a payout of only 990 euros. The debit interest is 5% based on the nominal value of 1000 euros, whereas the effective annual interest rate is 6.06%.

An important tip: Many banks try to avoid early repayment and the associated loss of income, and demand early repayment penalties. These are also regulated by law.

How can borrowing and effective interest rates be reduced?

As a rule, the effective interest rate cannot be influenced by the borrower. Here it is up to the lender to make a suitable offer. When it comes to borrowing interest, however, there are a number of ways to lower the interest rate and thus obtain a more attractive offer:

  • second borrower with income
  • guarantee
  • Collateral also usually significantly reduces the agreed interest rate. The higher the security offered by the borrower, the higher the likelihood of an interest rate cut. Real estate, but also other valuables such as a car, are well suited for this.

Conclusion: Really consider all factors when comparing loans!

As a consumer, the debit interest and the effective interest rate can quickly become confused. To prevent this from happening, it is important to find out about the terminology and to check all important contract contents before signing. An APR is a hidden processing fee, but it can be reduced through early repayment. The only important thing is that the loan agreement also allows special repayment and that no prepayment penalties have to be paid. Because these can sometimes differ significantly from the agreed interest and represent a not inconsiderable cost factor. Especially with larger loans, for which a later debt rescheduling comes into consideration, such a contractual clause would not be optimal and should therefore be avoided whenever possible. When comparing loans, the basis for the calculation is always the effective interest rate. It shows the total costs that must be taken into account for the loan. The debit interest becomes interesting when it comes to redeeming the loan early.

My name is Quang Lam and I work at Hegner Möller GmbH as Marketing Director. I am very interested in finance and sports. In my free time I like to go running and I also run a running blog. For the Best Credit blog I only write about topics that really interest me.

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