Business loan interest rates are generally quoted in EIR (effective interest rate).
What does EIR mean?
The effective rate is the actual cost of borrowing & is generally amortized on a monthly reducing principal balance basis.
Frankly put, the principal (original) loan amount is decreased monthly via the monthly installments paid.
For the initial periods of the loan tenure, a more significant portion of the monthly installment payments will be apportioned towards the loan’s interest portion.
Most SME owners have usually overlooked the calculation of EIR.
When quoted 10% p.a. EIR interest for loan amount $100K, most will mentally derive interest per year of $10K.
The actual net interest paid for a year on the above example is only $5,499. That’s why it’s normal to be quoted the nominal rate (also known as a simple or flat rate) for business loan products to simplify the calculation.
Using the same example, the nominal interest rate for 10% p.a. EIR will be 5.5% p.a. flat rate. The amortization table will give a clearer picture of the calculation for EIR.