The true annual cost of borrowing after considering compounding and certain fees.
For example, a business borrows $50,000 at a stated rate of 8%, but the lender also charges a 1.5% origination fee and requires a compensating balance. After accounting for these costs, the effective interest rate works out to approximately 10.2% annually.
Why it matters: It exposes the true cost of debt by factoring in compounding, showing the actual impact on the bottom line.
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