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Most efficient method for converting

flat rate interest to APR.
Asked 9 years, 4 months ago Modified 4 years, 5 months ago

Viewed 59k times

A while ago, a rather sneaky car salesman tried to

sell me a car financing deal, advertising an
5 'incredibly low' annual interest rate of 1.5%.
What he later revealed that this was the 'flat rate'
(meaning the interest is charged on the original
balance, and doesn't decrease with the balance
over time).

The standard for advertising interest is APR

(annual percentage rate), where the interest
charged decreases in proportion to the balance.
Hence the sneaky!

I was able to calculate what the interest for the

flat rate would be (merely 1.5% of the loan, fixed
over the number of months), but I was unable to
take that total figure of interest charged and then
convert it to the appropriate APR for
comparison.

I'm good with numbers but not a mathematician.

To the best of my knowledge I would need to use
some kind of trial and error of various
percentages (a function that oscillates perhaps?)
to find an APR which most closely matched the
final interest figure.

What would be the most appropriate

mathematical method for achieving this?

Please feel free to edit this question to add

appropriate tags - I don't know enough
terminology to appropriately tag the question.

finance fractions

Share Cite Follow asked Feb 28, 2013 at 11:43

monkeymatrix
97 1 1 7

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Sorted by:
7 Answers
Highest score (default)

There isn't a single correct answer for your

question - in fact, the method by which financial
5 firms calculate APRs vary too. However, if you're
willing to use the following definition as an
estimate (and if you ignore the time value of
money - that is, you value one dollar today as the
same as one dollar a year later) you can use the
following idea.

Calculate the total amount that you will have

to pay at the 1.5% interest rate. For example,
for a $10,000 loan over 10 years, you will be
paying a total of

$10, 000 × (1 + 0.015 × 10) = $11500

Assuming equal monthly installments,

calculate your monthly installment
payments.

$11500
= $95.83
120
Substitute that value as 𝑐 in the monthly
mortgage payment formula. This formula
calculates the monthly installments you would
make on a loan where the interest charge
depends on the balance. The equation can be
found here, but I've typed it out for you:

http://en.wikipedia.org/wiki/Mortgage_calculat
or#Monthly_payment_formula

𝑟𝑃
𝑐=
1 − (1 + 𝑟)−𝑁
1
𝑟 is 12
the annual interest rate

𝑃 is the loan principal - in this case

$10,000

𝑁 is the number of payments to be made, in

this case 120 months.

There is no analytic way to solve this problem.

However, if you are just interested in the answer,

this function in EXCEL will do the trick:
=RATE(120, -95.83, 10000, 0)*12 , or more
generally, =RATE(N, -C, P, 0)*12 to give you
the annual rate.

For this example of a 10 year loan, the APR is

only 2.86% - sounds OK to me! :)

Share Cite Follow answered Feb 28, 2013 at 12:34

Vincent Tjeng
3,264 1 19 34

I just want to correct something from Vincent

Tjeng's response. The example of: 10,000 x
(1+.015x10) = 11500 should be as follows:
10,000 x (1+.015x120) = 18000 Payment
amount would be as follows: 18000/120 = 150
The interest rate using the EXCEL RATE
function: =RATE(120,-150,10000,0)*12 =
13.11672473% APR Still not a bad APR
compared to credit card rates, but much greater
than the 2.86% APR. – user137393 Mar 23,
2014 at 14:50

Add a comment

First, you summarize the cash flow. We

normalize the total loan to 1 , since its magnitude
3 doesn't affect the calculation: So you pay an
interest of 𝑓 = 0.015/12 per month. Let's say
you pay the whole thing back in equal
installments over 𝑚 months: Then the cash flow
can be summarized as

{ 𝑚1 + 𝑓
−1 at 𝑡 = 0,
𝑐(𝑡) = 1 2 𝑚
at 𝑡 = 12 , 12
, … , 12 .

At an effective interest rate 𝑟 you should have

𝑐(𝑡)(1 + 𝑟)−𝑡 = 0,
∑
𝑡

which in the present case becomes (after some

manipulation – you need to know the sum of a
finite geometric series)

𝜌 − 𝜌𝑚+1
( 𝑚 + 𝑓) 1 − 𝜌 = 1
1

where 𝜌 = (1 + 𝑟)−1/12.
You will have to solve that by some numerical
scheme (Newton's method for example).

Share Cite Follow edited Feb 28, 2013 at 18:04

answered Feb 28, 2013 at 12:30

Harald Hanche-Olsen
30.8k 2 54 77

I was playing around with the numbers and

realised that at interest of 1.5%, the APR is
maximum at 50 months (2.88463%). Do you
have any idea why? I thought that it would
increase without limit. – Vincent Tjeng Feb 28,
2013 at 12:40

@VincentTjeng The longer your loan term, the

less benefit you get by reducing interest on a
monthly basis, so you have more payments that
are closer to the flat rate. Offhand, I suspect that
might be why. – Emily Feb 28, 2013 at 18:06

I think one way to understand it is that in the

limit 𝑚 → ∞, the 1/𝑚 term drops out, so it's like
you're just paying the interest forever and
making no down payments. But the present
value of a fixed monthly payment from now to
infinity is finite, and after a while you are
beginning to see the beneficial side of making no
down payments. – Harald Hanche-Olsen Feb
28, 2013 at 18:07

@Arkamis and Harald: thank you, it makes

more sense now. – Vincent Tjeng Mar 1, 2013
at 2:18

Add a comment

Easy way to convert reducing rate to flat, simply

flat rate divided by 1.83
1
Example = reducing rate is 18% now u want to
convert in to flat rate so 18 ÷1.83 = 9.8%

Share Cite Follow answered Apr 20, 2015 at 15:36

Athar ahmed
11 1
Add a comment

My rule of thumb to convert APR to Flat or vice

versa is as such:
1
APR = Flat rate x 2 x No. of payments / No. of
payments + 1

Example: 4% x 2 x 12 / 12 + 1 = 96 / 13 = 7.38%
approx.

Share Cite Follow edited Mar 15, 2016 at 11:36

Daniel R
3,143 3 25 39

answered Mar 15, 2016 at 11:09

Abdul Rahman Sharif
11 1
Add a comment

If you want to know what you are really paying -

"Effective APR", and you know exactly when you
0 will be making payments you should use the
following:

𝑁
𝑃𝑖
0=
∑ 𝑑𝑖−𝑑1
𝑖=1 (1 + 𝑟𝑎𝑡𝑒) 365

You can do this practically by using

XIRR(values,dates)

It returns the "Effective APR"

It works for periodic and a-periodic payments,

excel screen shot example

Share Cite Follow answered Apr 12, 2016 at 22:14

Glen Thompson
101 2
Add a comment

10000 paid at a rate of 5% flat over (say) 3 years

= 10,000 x 5% = 500 PA x3 = 1,500 + 10,000 =
0 11,500 div by 36 = 319.44 PM. Now as you've
paid back capital and interest on a straight line
asset loan (unlike "bent" mortgage amortisation
tables) you have had approximately use of only
half the money. Why? because you paid one 36th
of the capital back in equal monthly instalments
one month in arrears. Therefore the APR is 9.9%
(not quite double the flat rate as you paid in
arrears. Comments.

Share Cite Follow edited Jan 16, 2018 at 10:10

answered Jan 16, 2018 at 10:01

Chris David
1 2
Add a comment

Rather than getting down to this level that

requires a Masters degree in Applied
-2 Mathematics, I use a simple rule of thumb that
closely equates one with the other. Apart from
extremely low or high interest rates, it is close
enough the draw a good comparison. Put simply,
divide the variable interest by 2 and then add 2 to
get the eqivalent flat interset rate. Eg a 30%
variable rate approximates to 30 / 2 + 2 = 17%
flat. 20% approxiamtes t0 20 / 2 + 2 = 12% flat.
How easy is that!

Share Cite Follow answered Jul 8, 2013 at 4:08

Barney
1
Add a comment

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