Effective Interest Rate Calculation

Download our example of an effective interest rate calculation [ Microsoft Excel .xls file 143KB ]

Most South African bonds are subject to variable monthly interest rates that are linked to the prime bank interest rate. This rate fluctuates based on the fiscal policy that is determined by the South African Reserve Bank and it is therefore not a simple exercise for home owners to calculate the effective interest rate of a bond over the entire bond period. This calculation consists of two main components - the bond repayments that have already been effected since the start of the bond repayment period and the bond repayments that will have to be paid over the remaining bond period.

In order for the effective interest rate calculation to be accurate, bond repayments that have already been made need to be included in the calculation by using the actual interest rates that were in effect during the appropriate bond repayment period. In most cases, the bond interest rate is linked to the prime interest rate and the appropriate bond interest rate can therefore be determined by simply looking up the appropriate prime interest rates for the particular periods and then applying the interest rate discount or premium to these rates. The bond interest rates that are used for future bond repayment periods are a bit more subjective. The current prime interest rate can be used for this component of the calculation or you may wish to include forecasted interest rates for the remaining bond period.

Once the interest rates that need to be included in the calculation have been established, the total of all the bond repayment amounts over the entire bond period needs to be calculated. This amount is then divided by the number of repayment periods in the bond term in order to calculate the average monthly bond repayment amount. The average monthly bond repayment amount is then included in a financial calculation together with the original bond amount and the bond period in order to determine the effective interest rate of the bond over the entire bond period.

This all sounds quite complex and it probably is but we have developed a comprehensive Microsoft Excel based template that automatically calculates the effective interest rate of a bond and only requires basic user input. This unique template is included in our template subscription and an example of the template can be downloaded by clicking link at the top of this page.

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