Evaluating Effective Annual Cost When Comparing Short-Term Loan Offers

How do you calculate Effective Annual Cost (EAC) for short-term loans?

Effective Annual Cost (EAC) is the practical way to compare short-term loan offers that use different rates, fees, or repayment schedules. Instead of focusing only on a lender’s advertised rate, EAC tells you the real annual percentage cost a borrower pays after fees and timing are included. In my 15 years advising borrowers, I’ve seen EAC reveal the cheaper option even when the nominal rate looks worse.

Why EAC matters for short-term loans

Short-term loans often combine higher advertised rates, one-time fees (origination, underwriting, funding), and unusual repayment patterns (single repayment, weekly installments, or factor rates). The Annual Percentage Rate (APR) required by the Truth in Lending Act (TILA) discloses finance charges, but APR and EAC are not always the same metric borrowers need when fees are large or proceeds are reduced by upfront charges. The Consumer Financial Protection Bureau (CFPB) requires APR disclosures for many consumer loans; consult CFPB materials for legal protections and disclosure rules (https://www.consumerfinance.gov).

Use EAC when:

• Fees are paid up front and reduce the cash you receive.
• Interest compounds on the outstanding balance.
• Loan terms are shorter than a year or have nonstandard payback schedules.

The simple EAC formulas you’ll use

Two common EAC formulations cover the majority of short-term loan comparisons:

1) For a loan where fees and interest are paid over exactly one year (or you want to annualize a one-year loan):

EAC = (Total Repayment / Principal) − 1

Total Repayment = principal + total interest paid + fees

2) When fees reduce the net proceeds (origination fee deducted up front) or when you need to annualize an amount for a term that is not exactly one year, use:

EAC = (Total Repayment / Net Proceeds)^(1 / years) − 1

Net Proceeds = Principal − Upfront Fees

This second form is the more accurate and more conservative method for comparing true cost because it accounts for the fact that you received less than the nominal principal at closing.

Step-by-step example (one-year loans)

Two one-year loan offers for a $10,000 nominal loan:

• Loan A: 5% interest, $300 up-front fee. Interest is simple (paid over the year). The lender pays out $9,700 if the fee is deducted up front.
• Loan B: 6% interest, $150 up-front fee. Net proceeds $9,850.

Method A — simple total repayment approach (applies if fees do not reduce proceeds or you want a quick comparison):

Loan A total interest = $10,000 × 5% = $500
Loan A total repayment = $10,000 + $500 + $300 = $10,800
EAC_A = $10,800 / $10,000 − 1 = 0.08 or 8.0%

Loan B total interest = $10,000 × 6% = $600
Loan B total repayment = $10,000 + $600 + $150 = $10,750
EAC_B = $10,750 / $10,000 − 1 = 0.075 or 7.5%

Method B — conservative (fees deducted from proceeds; annualized from net proceeds):

Loan A: Net proceeds = $10,000 − $300 = $9,700
EAC_A = (10,800 / 9,700)^(1/1) − 1 = 0.1134 or 11.34%

Loan B: Net proceeds = $10,000 − $150 = $9,850
EAC_B = (10,750 / 9,850)^(1/1) − 1 = 0.0919 or 9.19%

Result: When you account for fees deducted up front, both loans look more expensive, and Loan B remains cheaper — but the difference widens. That’s why the conservative formula matters when fees are taken from proceeds.

Example: less-than-one-year loans or single-payment advances

If a lender offers a 60‑day advance for $1,000 with a $100 fee and no periodic interest, you can annualize the cost:

Total Repayment = $1,000 + $100 = $1,100
Net Proceeds = if fee is deducted up front, $900
Term in years = 60/365 ≈ 0.1644

EAC = (1,100 / 900)^(1 / 0.1644) − 1

This produces a very large EAC (often several hundred percent) — the point: short-term, high-fee advances can have extreme EACs and deserve scrutiny. For an easier approximation on short terms, many borrowers calculate the simple periodic rate (fee / net proceeds) and then annualize by multiplying by (365 / days) to get a rough annualized rate.

When to use APR vs EAC vs EAR

• APR (Annual Percentage Rate) — legally required disclosure that converts finance charges to an annual rate under TILA. Useful for many conventional loans, but the APR formula has rules that may not reflect net proceeds or certain non-finance fees.
• EAC — best when you want the practical annualized cost to the borrower, especially if fees reduce proceeds or payments are irregular. EAC is often more conservative than APR.
• EAR (Effective Annual Rate) — measures the effect of compounding on an interest rate (useful for deposits and some loans); see our guide on EAR vs APR.

See our coverage on how short-term loan pricing works for more on factor rates, APR, and finance charges: How short-term personal loans are priced.

Practical checklist to compute EAC and choose the best offer

1. Get a written itemization of fees (origination, underwriting, late fees, prepayment penalties). If the lender won’t provide this, don’t proceed.
2. Identify whether fees are deducted from proceeds or added to the principal.
3. Calculate total repayment (all payments you will make) and net proceeds (what you actually receive).
4. Use the conservative EAC formula: EAC = (Total Repayment / Net Proceeds)^(1/years) − 1.
5. If the term is under one year, annualize carefully — the shorter the term, the higher the annualized EAC.
6. Compare using the same method across offers. When in doubt, use the conservative net-proceeds method.

Common borrower mistakes and how to avoid them

• Mistake: Comparing only nominal interest rates. Fix: Always include fees and the timing of fees.
• Mistake: Ignoring whether fees reduce the money you get. Fix: Compute net proceeds and use the conservative formula.
• Mistake: Forgetting compounding and payment timing. Fix: If payments are monthly, present-value methods or a simple annualization can be used; the conservative EAC still works for comparison.

Negotiation and practical tips

• Ask lenders to roll fees into the principal (if that lowers your EAC after comparing net proceeds vs added principal). Some lenders will offer optional fee structures.
• Check whether prepayment is allowed without penalty; paying early lowers the effective cost.
• Shop multiple offers and compare using the same EAC method.
• Use our article on origination fees and APR comparisons to understand how different fee treatments change the comparison.

Regulatory context and protections

Federal law (TILA) requires many lenders to disclose APR so consumers can compare offers; the CFPB enforces consumer protections and provides resources on payday and short-term lending practices (https://www.consumerfinance.gov). State rules may limit fees, require cooling-off periods, or cap effective rates — check local regulations if you’re considering high-fee short-term credit.

Quick decision guide

• If the loan term is short and fees are large: calculate conservative EAC (net proceeds method).
• If the fee structure is complex (multiple fees, balloon payments): ask for an amortization schedule and run the EAC using actual cash flows.
• If you’re unsure, bring offers to a trusted advisor or use a spreadsheet that converts cash flows to an annualized rate.

Final professional note and disclaimer

In my practice I regularly re-run EAC comparisons for clients who initially selected loans by nominal rate alone; recalculating EAC typically reveals a better overall option. This article is educational and not tailored financial advice. For decisions that affect your finances materially, consult a licensed financial advisor or attorney familiar with consumer lending and your state’s rules.

Sources & further reading

• Consumer Financial Protection Bureau (CFPB): https://www.consumerfinance.gov
• Understanding Effective Annual Rate (EAR) vs APR — FinHelp: https://finhelp.io/glossary/understanding-effective-annual-rate-ear-vs-apr/
• How Short-Term Personal Loans Are Priced — FinHelp: https://finhelp.io/glossary/how-short-term-personal-loans-are-priced-apr-factor-rates-and-finance-charges/
• The Role of Origination Fees in APR Comparisons — FinHelp: https://finhelp.io/glossary/the-role-of-origination-fees-in-apr-comparisons/

(Prepared for educational purposes only.)