EAR's


J

JanD601

Please no patronizing or condescending remarks please. I am currently taking Fundamentals of Corporate Finance. I have recently learned about EAR's, or as I like to call them real rates. I understand about the Truth in Lending Act congress passed because they couldn't do the math themselves to figure out what borrower's were really paying. My question is that now after all these years have passed why don't they amend this act and require lenders to quote the EAR instead? after all there is a big difference in paying back 18% versus 19.56%. Are finance people just as crooked as Congress now? They rather not let the unsuspecting borrower know they are actually paying back more than they realize?
 
B

Bob

Please no patronizing or condescending remarks please. I am currently taking Fundamentals of Corporate Finance. I have recently learned about EAR's, or as I like to call them real rates. I understand about the Truth in Lending Act congress passed because they couldn't do the math themselves to figure out what borrower's were really paying. My question is that now after all these years have passed why don't they amend this act and require lenders to quote the EAR instead? after all there is a big difference in paying back 18% versus 19.56%. Are finance people just as crooked as Congress now? They rather not let the unsuspecting borrower know they are actually paying back more than they realize?



OK, so tell us what an "EAR" is and how it differs from APR
 
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J

JD

I made one little error not 2 1/2% but 2.15% sorry
EAR stands for Effective Annual Rate. Now this next comes out of my text.
Given that an APR must be calculated and displayed, an obvious question arises: Is an APR an effective annual rate? No. If a bank quotes you a car loan at 12% APR compounded monthly you are not actually paying 12% on the loan. The EAR is found using this formula

EAR = [1 + (APR/m)]^m - 1 m stands for number of times a year the APR is compounded

So, here is the equation EAR = [1 + (.12/12)]^12 - 1
EAR = 1.01^12 - 1
EAR = 12.6825%
So you see you are actually paying a little more than 2/3 a percent more than what was quoted you. If you have a financial calculator this can easily be calculated by using the ICONV queue You plug 12 into the NOM and 12 into C/Y (which means compounded yearly) and on EFF you press the compute queue to find your real rate.

The rate you actually pays depends on how many times a year the loan or investment is compunded. If you are given a 10% APR and the account is compounded yearly then naturally the EAR is the same as the APR. If it is compounded semi annually it is actually 10.25%. Quarterly 10.38%. Monthly 10.47%. Daily 10.52% Do you see how this changes? This is why I want to know why the EAR is not the law in the Truth in Lending laws.

Let me really land you on your ear. Most people have a department store credit card with an APR of 21% Let's just say that the account is compounded monthly. The rate you are really paying is 23.1439% Whoa! you are actually paying almost 2 1/2 percent higher than the APR. Hope this cleared up what you wanted to know.
Jan
Please no patronizing or condescending remarks please. I am currently taking Fundamentals of Corporate Finance. I have recently learned about EAR's, or as I like to call them real rates. I understand about the Truth in Lending Act congress passed because they couldn't do the math themselves to figure out what borrower's were really paying. My question is that now after all these years have passed why don't they amend this act and require lenders to quote the EAR instead? after all there is a big difference in paying back 18% versus 19.56%. Are finance people just as crooked as Congress now? They rather not let the unsuspecting borrower know they are actually paying back more than they realize?



OK, so tell us what an "EAR" is and how it differs from APR
 

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