If a loan has an amount of $100,000, an interest rate of 7%, and term of 180 months, what is the best estimate of the effective borrowing cost if prepaid after six years?

To determine the effective borrowing cost when a loan is prepaid, it’s important to consider not only the stated interest rate of 7%, but also the impact of the loan’s prepayment after a certain period—in this case, six years (or 72 months).

When the loan is prepaid, the borrower typically pays off the remaining principal along with any interest accrued up to that point. This can result in an effective interest rate that is higher than the original stated rate because the borrower does not utilize the full amortization period, which in this scenario is set for 180 months.

Calculating the effective borrowing cost involves analyzing the total costs incurred during the period the loan is active, including any early payoff penalties, and comparing them to the amount of money borrowed. This estimation can also incorporate the interest saved by not carrying the loan to full maturity.

In this case, if we assume the borrower pays off the $100,000 loan after 72 months, the remaining principal balance at that time will be significantly less than the original amount still owed if the loan were allowed to reach its maturity.

The effective borrowing cost factors in this early payoff, resulting in a higher percentage than the initial stated interest rate because the borrower ends up paying a