Cost of Credit Formula
The cost of credit is often expressed as an annual percentage rate (APR). It represents the real cost of borrowing money, taking into account the interest rate, along with any additional fees and charges.
While there is not a single standardized formula for calculating the cost of credit due to varying loan conditions and lender policies, a general formula for calculating the Annual Percentage Rate (APR) is:
APR = [(Fees + Interest) / Loan Amount] / Number of Days in Loan Term * 365 * 100%
Where:
- “Fees” represent any additional charges or fees associated with the loan.
- “Interest” is the total amount of interest paid over the life of the loan.
- “Loan Amount” is the initial amount of money borrowed.
- “Number of Days in Loan Term” is the length of the loan term in days.
Please note that this is a simplified formula and the actual calculation can be more complex, particularly for loans with compound interest or varying interest rates. It’s also worth noting that different jurisdictions may have different methods for calculating APR, so it’s always a good idea to check the specific regulations in your area or consult with a financial advisor.
Example of the Cost of Credit Formula
Let’s say you take out a loan for $10,000. The loan term is one year (365 days). The interest rate on the loan is 5%, so the total amount of interest you’ll pay over the life of the loan is $500 ($10,000 * 5%). The loan also has an origination fee of $200.
We can plug these numbers into the formula to calculate the APR:
APR = [(Fees + Interest) / Loan Amount] / Number of Days in Loan Term * 365 * 100%
= [($200 + $500) / $10,000] / 365 * 365 * 100%
= [0.07] * 100%
= 7%
So, the APR of the loan, considering both the interest and the fees, is 7%.
Remember, this is a simplified example. Actual loan calculations can be more complex, especially if the loan involves compound interest or a variable interest rate.
