If you compare the effective and relative rates of remuneration, you find out that any selected type gives the same results at the end of interest period. The differences could occur within the interest period and following it.
Use Annual Percentage Rate in Annual Remuneration
The principal in amount of €100,000 is remunerated from January 1st, 2007 till December 31st, 2007. That is, for 365 days altogether. Here we used the 20% interest rate. To present calculation in a more clear way, we entered the interest rate for each month separately. However, if you do not use a variable interest rate, it need not be applied in practical use.
Because the principal undergoes an annualized remuneration and annual percentage rate is used, you get the same results regardless of the selected type of remuneration.
The following can easily be observed from the below calculation:
- Using effective interest rate from January 1st, 2007 till June 30th, 2007, that is, approximately half of the remuneration period, the interest would amount to €9,462.47. This is €455.35 less than you would get using the relative rate (Here the interest for the same period amount to €9,917.82).
- Applying effective interest rate in the second half of the remuneration period, that is, from July 1st, 2007 till December 31st, 2007, the interest would amount to €10,537.54. This is €455.34 more than by using the relative rate (Here the interest for the same period amount to €10,082.20).
1. Effective Interest Rate
Calculation shows that the amount of interest grows proportionally by individual remunerated month. The total of annual percentage rate amounts to 20% of the principal. Below it can easily be observed that using the effective interest rate would amount to €9,917.82 till June 30th, 2007.
Due to relative mistakes occurring in rounding by individual month the total amount of interest differs from the actual amount by €0.01.
Using the annual percentage rate of 20% and entering it only for January 1st, 2007, you would get total interest calculation. This way no mistakes occur when rounding interest by months:
2. Relative Interest Rate
Tnterest amount by individual months is unchanged if the number of remuneration days remains the same (compare for example January and March, April and June, etc).
Due to relative mistakes occurring in rounding by individual month the total amount of interest differs from the actual amount by €0.02.
Using the annual percentage rate of 20% and entering it only for January 1st, 2007, you would get total interest calculation. This way no mistakes occur when rounding interest by months:
