Formula to Estimate Effective Cost
Precise determination of effective cost requires complex mathematics. You can calculate an estimate of effective cost using a fairly simple formula. First, find the total finance charges by adding all of the interest charged over the life of the loan to other fees. The formula to approximate effective cost is 2(F N)/(A (T + 1)). F equals total finance charges, N is the number of payments per year, A equals the total repayment amount and T is the total number of payments. Suppose you borrow $1,000 and the finance charges total $250, so the amount you must repay equals $1,250. You make monthly payments over a two-year period. You have 2($250 12) divided by ($1,250) (24 + 1). This works out to an approximate effective cost or APR of 19.2 percent.