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An effective interest rate is a rate that takes into account any cash rebates paid to the borrower.
For example, if the contract rate is 3.00% on a $200,000 five-year mortgage amortized over 25 years, and the borrower is getting $1,000 cash back, the effective rate will be lower than 3.00% because the cash lowers the effective borrowing cost. In this example, the effective rate would be approximately 2.88%.
See Also: Contract Rate« Back to Glossary Index