Understanding Effective-Interest Rate: How Compounding Frequency Affects Your Loan

When the compounding frequency is greater than once a year, the effective-interest rate will always be less than the stated rate.-true-false

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When the compounding frequency is greater than once a year, the effective-interest rate will be greater than the stated rate. The effective-interest rate takes into account the compounding effect on the initial principal, meaning that the more frequently the interest is compounded, the higher the effective-interest rate becomes. For example, if a loan has an annual stated interest rate of 5%, but interest is compounded monthly, the effective-interest rate will be higher than 5% since interest is being added to the balance more frequently.

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