new engineering graduate student who started a consulting bu

new engineering graduate student who started a consulting business borrowed money for 1 year to buy necessary equipment and furnishings. The amount of the loan was $16,000, and it had an interest rate of 11% per year. Because the new graduate student did not have a credit history, the bank made him buy loan default insurance at the cost of 5% of the loan and charged a loan origination fee of $300, both paid up front. What was the effective interest rate that the engineer paid for the loan?

Solution

Interest @ 11% for $16,000 = $1,760

5% default insurance cost = $800

Origination cost = $300

Total costs toward the loan = 1760 + 800 + 300 = $2,860

Effective interest rate for 1 year of the loan = 2860 / 16000 x 100

Effective interest rate: 17.875%

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