What Is the Effective Interest Rate and Why It's Almost Always Higher Than the One Advertised by the Bank

Understanding how to choose a loan that won’t drain your budget

When applying for a loan — whether it's a personal loan, mortgage, or car loan — the first thing you’re usually told is the interest rate. It sounds appealing: “Loan at 11%” or “Only 9.9% interest.” But in most cases, these numbers don’t paint the full financial picture.

The key figure to focus on is the effective interest rate — this is what actually shows how much the loan will really cost you.

Let’s break it down:

1. what these two types of interest rates mean,
2. how they differ,
3. why it matters especially in Armenia,
4. and how to pick the most beneficial loan.

Why do these details matter?

Because a loan is a long-term commitment. Even a small difference of 2–3 percentage points can lead to significant overpayments. At first glance, the terms might seem clear and simple, but to avoid surprises, it’s crucial to understand how the total cost of the loan is actually formed.

What is the nominal (or advertised) interest rate?

The nominal interest rate is essentially the price of the loan. For example, if you borrow 1 million AMD at 12% per year, you will pay 120,000 AMD in interest over one year. This rate is used to calculate your monthly payment schedule.

However, this figure does not account for all your actual expenses. It excludes:

1. insurance fees,
2. processing or administrative fees,
3. account servicing charges,
4. and other required payments that may be part of the loan agreement.

So what is the effective interest rate?

The effective interest rate is the total cost of borrowing. It includes all mandatory payments tied to the loan. This is the number that reflects how much you will actually pay for using the bank’s money.

It typically includes:

1. the nominal interest rate,
2. loan processing fees,
3. account or card maintenance charges,
4. insurance payments (if required to receive the loan),
5. and any other obligatory costs (e.g., property valuation in case of a mortgage).

Example

You take out a loan of 1,000,000 AMD at 10% annual interest. In theory, you would pay 100,000 AMD in interest over the year. But if the loan also includes:

1. a processing fee of 50,000 AMD,
2. insurance costing 25,000 AMD,

then in reality, you only receive 925,000 AMD in hand, while interest is still calculated on the full 1,000,000 AMD.

As a result, the effective interest rate ends up around 17–18% annually, and your total overpayment may be much higher than expected.

What This Looks Like in Practice (as of May 2025, Armenia)

AFM analyzed dozens of actual loan offers from banks in Armenia. Here's a general picture:

The difference between the nominal and effective rate can reach 3–4 percentage points — and that directly impacts the final cost of your loan.

Can the Effective Rate Be Lower Than the Nominal One?

Yes, although it’s rare. This usually happens under government-subsidized loan programs, where a portion of the interest is covered by the state.

For example:

You apply for a mortgage with a 12% annual interest rate, but under a government support program, 4% is subsidized. In this case, you're effectively paying 8%, and after accounting for all associated costs, the effective rate may actually be lower than the nominal rate.

Such conditions are common for:

1. mortgage programs for young families,
2. loans for military personnel,
3. agricultural loan programs, and others.

However, even these loans require careful review — fees and insurance costs can significantly affect the final loan cost.

Why Is the Effective Rate Almost Always Higher?

The effective interest rate includes all expenses necessary to obtain the loan:

1. contract processing fees,
2. insurance payments,
3. account maintenance fees, etc.

The nominal rate is more often used in advertising — it makes the offer seem more attractive.

The effective rate, on the other hand, reflects the true cost of borrowing.

Since 2023, the Central Bank of Armenia has mandated that banks disclose the effective rate in loan agreements. However, advertising materials still typically show only the nominal rate.

How to Choose a Cost-Effective Loan: Step-by-Step instructions

1. Look at the effective rate, not just the nominal rate

That’s what reflects your real overpayment.

2. Account for all mandatory costs

Fees, insurance, and service charges all affect the total loan cost.

3. Use calculators

AFM offers a loan calculator that helps you estimate the effective rate and compare different banks' offers in just a minute.

4. Review the contract before signing

Request full transparency: payment schedule, all commissions, and the final loan cost.

Final Takeaway

If you want to take out a loan on favorable terms, focus on the effective interest rate — not the one you see in ads.

The nominal rate may look attractive, but only the effective rate shows the true cost of the loan.

At AFM, we monitor and update loan offers from banks across Armenia daily to help you make informed decisions.

As our comparisons show: even with the same advertised rate, the difference in total overpayment can reach tens of thousands of drams. That’s money you could save — instead of losing it due to hidden costs.

One last tip:

Always check the full terms, calculate all expenses, and don’t rush into signing a contract before understanding the actual loan cost.

And to avoid doing the math manually, use AFM tools — and find the loan that’s truly right for you.