EFFECTIVE INTEREST IN HIRE PURCHASE

[Pages:3]EFFECTIVE INTEREST IN HIRE PURCHASE

The effective rate of interest in a hire purchase agreement is the interest rate that would be charged in an equivalent reducing balance loan. The effective rate of interest is always higher than the flat rate of interest because the effective interest rate takes into account the fact that the amount owed is being progressively reduced by the regular instalment payments, while simple interest does not take this into account.

EFFECTIVE RATE OF INTEREST FORMULA

where n = no. of instalments over the life of the contract = annual flat rate of interest charged in contract

The effective rate of interest is roughly about twice the flat rate of interest. The more repayments there are, the closer it is to double the flat rate.

EXAMPLE 1:

EXAMPLE 2:

Calculate the effective rate of interest being charged.

Calculate the effective rate of interest that Shaun is being charged in this agreement, correct to one decimal place.

Question

Calculate the effective rate of interest under the terms of this agreement.

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