Why the contract rate can understate borrowing cost
The contract rate sets the amortizing payment on the full loan amount. An origination fee taken from the disbursement reduces cash received while the payment schedule stays the same, so the effective annual cost is higher than the contract rate.
Amount received = loan amount − origination fee
Monthly payment uses the full loan amount, contract rate, and term
Find monthly rate j such that amount received = Σ payment ÷ (1+j)^k
Estimated effective annual cost = (1+j)^12 − 1
Monthly payment uses the full loan amount, contract rate, and term
Find monthly rate j such that amount received = Σ payment ÷ (1+j)^k
Estimated effective annual cost = (1+j)^12 − 1
Example
A $20,000 loan at 8% for 48 months with a $400 origination fee pays as if the full $20,000 were borrowed, but only $19,600 is received. The estimated effective annual cost is above 8%.
This is a planning estimate
Official APR disclosures can include a different fee set, day-count, and compounding rule. This page models one fixed rate, equal monthly payments, and a single fee deducted at disbursement.