You are looking at a one-year loan of $10,000. The interest rate is quoted as 8

Question

You are looking at a one-year loan of $10,000. The interest rate is quoted as 8 percent plus 5 points. A point on a loan is simply 1 percent (one percentage point) of the loan amount. Quotes similar to this one are very common with home mortgages. The interest rate quotation in this example requires the borrower to pay 5 points to the lender up front and repay the loan later with 8 percent interest. What is the effective rate you are paying on this loan? Assume that you will make one payment at the end of the year (i.e., this is not a monthly loan). The answer is below, but I do not know how to get it.

d. 13.68 percent

Explanation / Answer

Hi,

Please find the correct answer as follows:

Loan amount received = $10,000*(1-5%) = $9,500

Loan repayment amount = $10,000*(1+8%) = $10800

You only got $9500 funded yet were charged interest on $10,000

=>$10800 = $9,500*(1 + r)

=> r = 13.68%

hence, the correct answer is 13.68%

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