Effective Interest Rate (EIR) Calculator: the true cost of your loan

Why the advertised rate is not what you pay

Every loan advertisement quotes one number: the interest rate. That number is applied to your outstanding balance each month, and it is the only thing an EMI calculator uses. But a loan also comes with a processing fee, 18% GST on that fee, sometimes a bundled insurance premium, and charges if you repay early. None of those appear in the EMI. They come out of the money you receive on day one, or they get added to what you owe. Either way, you repay as if you had received the full amount. The effective interest rate, or EIR, is the single annual rate that accounts for all of it.

Take a Rs 10,00,000 personal loan at 10% for 5 years with a 1% processing fee. The fee is Rs 10,000, GST adds Rs 1,800, so Rs 11,800 is deducted and you receive Rs 9,88,200. Your EMI is still Rs 21,247 a month on the full Rs 10,00,000. The EIR works out to about 11.0%, not 10%. Part of that is monthly compounding, which already makes a 10% nominal rate 10.47% effective; the fee adds the rest. Shorten the tenure to two years and the same fee pushes the EIR to about 11.8%, because the fee is spread over fewer months.

Flat rate versus reducing balance

Some lenders, especially for vehicle, consumer-durable and small-business loans, quote a flat rate. Interest is calculated on the original loan amount for the entire tenure, even though you are repaying principal every month. On a reducing-balance loan, interest is charged only on what you still owe. The difference is large and grows with tenure.

The rule of thumb that a flat rate is “roughly double” the reducing rate is close enough for short loans. The table shows nominal reducing-balance rates, the way lenders advertise them; the EIR headline above is the effective annual rate, which is a little higher again because of monthly compounding. Switch the calculator to flat rate and it shows the exact equivalent in the warnings box.

What counts toward the EIR, and what does not

Include anything you pay because you took the loan and that the lender keeps: processing fee, documentation charges, login fees, and GST on all of them. Bundled insurance is a judgement call. If the lender makes it mandatory and you would not have bought it otherwise, count it. If it is a genuine third-party policy you wanted anyway, untick “Count in EIR” and it will show in the total cost but not the rate. Stamp duty on a mortgage deed goes to the state, not the lender, and is usually excluded.

A charge can be deducted from disbursement (you receive less) or added to the loan (you receive the full amount but owe more and pay interest on the charge). The second is common for insurance premiums and is more expensive over a long tenure. Tick “Added to loan” to model it.

Prepayments and tranches

A part-prepayment either shortens the tenure while keeping the EMI, or lowers the EMI while keeping the tenure. Cutting tenure saves far more interest. Floating-rate home loans to individuals cannot carry prepayment charges under RBI rules, but fixed-rate loans and business loans usually do, typically 2% to 5% of the amount prepaid. Under-construction property loans are released in tranches, and you pay interest only on what has been disbursed; the advanced section models that.

The lender view: Ind AS 109 amortised cost

For a bank or NBFC the same cash flows define how interest income is booked. Ind AS 109, which mirrors IFRS 9, requires financial assets held for collection to be measured at amortised cost using the effective interest method. The origination fee is not income on day one; it reduces the initial carrying amount and is unwound into interest income over the life of the loan at the EIR. When the borrower prepays, expected cash flows change, the carrying amount is recalculated as the present value of the revised flows at the original EIR, and the difference is booked immediately (paragraph B5.4.6). The lender tab shows the monthly schedule, the totals by Indian financial year, and illustrative journal entries. GST is excluded from the lender rate because it is remitted, not earned.

How to use the result

• Compare offers on EIR, not on the advertised rate. A 0.5% lower headline rarely beats a 2% fee on a short loan.
• Ask the lender to waive or reduce the processing fee; it moves your EIR more than a small rate cut does.
• If quoted a flat rate, ask for the reducing-balance equivalent in writing before you sign.
• Download the schedule and keep it with the loan agreement; it makes prepayment decisions easy later.

This calculator is an estimate for planning. Lenders may round EMIs, use daily-balance interest, or apply charges differently. Ask for the Key Fact Statement, which RBI requires for retail loans and which must show the annualised percentage rate including fees.