What is the effective interest rate for a $190,000 loan at 6% over 5 years?

To determine the effective interest rate for a loan, it is important to consider not only the nominal interest rate but also the effect of compounding over the life of the loan. The effective interest rate reflects the true cost of borrowing as it takes into account compounding.

In this case, with a loan amount of $190,000 at a nominal interest rate of 6% over 5 years, the calculation for the effective interest rate typically involves finding the total interest paid over the term of the loan and how that translates to an annual percentage rate when adjusted for the effects of compounding.

When calculating the effective interest rate, one typically uses the formula for the future value of an investment compounded over multiple periods. For a loan, this would involve finding the total amount paid including interest, and then determining what nominal rate would yield that total amount when compounded annually.

For a loan term of 5 years, the compounding effect can slightly increase the effective rate compared to the stated nominal rate, which leads to the finding that the correct effective interest rate is approximately 6.14%. This calculation aligns with financial principles where the compound interest calculation can result in an effective rate that is higher than the nominal rate due to the frequency and method of interest application.