The loan represents a certain amount of cash that the credit institution has made available for use to the client, the borrower, on a contractual basis and under certain conditions. During the repayment of the loan, the user pays the cost of using the borrowed funds , ie interest.
The effective interest rate (EIR) is usually the real cost of the loan . Therefore, by comparing EIRs, clients gain insight into the cost of lending to various commercial banks.
The article deals with the subject in detail. If you’re just looking for the best line of credit and don’t have time to read, you can fill out a credit questionnaire right away.
What parameters determine the “price” of a loan?
Credit institutions determine the amount of interest on loans taken into account
- own cost of obtaining funds (eg interest on deposits),
- operating expenses (eg salaries of bank employees) and
- credit risk premium.
The level of risk premium, and thus interest rates, are influenced by the client’s creditworthiness, type of credit, contractual repayment period, debt security instruments, conditions and competition in the interbank market, inflation rate, country credit rating and more.
Basic interest on loans to citizens
When it comes to interest rates on retail loans, it is necessary to distinguish between regular interest rates and effective interest rates (EIR).
Based on regular or agreed interest rates, banks calculate interest during the loan repayment period and calculate the amount of the monthly annuity. In the narrower sense, this type of interest is the nominal interest rate (NIR).
If the loan is contracted at a fixed interest rate for the entire duration of the loan, regular interest is equal to the nominal interest rate.
The NCS represents the value indicated in the bank’s catalog and loan agreement. In the case of a variable interest rate, the repayment of the loan takes place at a market rate based interest rate.
The effective interest rate (EIR) informs broader and more visible coverage of borrowing costs.
Effective interest rate calculation
The EIR calculation method is unique to all Croatian banks and has been prescribed by the Croatian National Bank (CNB).
EIR is a decursive interest rate that is calculated using a compound interest account.
For the decursive method of calculating interest, the calculation of interest is carried out at the end of a certain period of time to the initial amount of the loan principal. In a compound interest account, the principal is variable, that is, the interest is calculated on both principal and interest.
The actual (calendar) number of days in a month and 365/366 days in a year is used in calculating the EIR. The EIR is reported annually at two decimal places.
The maximum EIR for retail loans is prescribed by law. In consumer lending, the EIR is equal to the rate of legal default interest plus two percentage points, namely 9.09%. The maximum EIR on home loans equals the statutory default interest rate – 7.09%.