Introduction to Cost of Borrowing


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Introduction to Cost of Borrowing

All of the cost of borrowing examples referenced on this page and elsewhere on this web site are still mathematically correct. The changes are in the wordage used by the Ontario Ministry of Finance.

The Ontario government refers (as of 2006) to the “Total Cost of Borrowing” as just the “Cost of Borrowing” now. The Cost of Borrowing is called the annual percentage rate, APR. In the exact words of the Ontario government, “APR means the cost of borrowing expressed as an annual rate on the principal referred”.

For every annual interest rate, AIR there is an effective interest rate, EIR. If the compounding is annual compounding then the AIR is the same as the EIR. If the compounding is more frequent than annual then the AIR is referred to as the nominal annual interest rate and the frequency of compounding is also stated. Using a current example of an AIR of 2.99% with semi-annual compounding or in other words a nominal annual interest rate of 2.99% with semi-annual compounding the EIR that corresponds to that 2.99% is 3.0123%. The 3.0123% is the actual interest rate the lender would receive IF they theoretically invested each payment at the same interest rate as each payment was received.

If the AIR of 2.99% rate was based upon a 4 year term (rates are reevaluated at the end of each TERM in Canada regardless of the length of the amortization period which determines the payment) and the processing fees charged to you by the lender were $250 then the new AIR would be 3.0256% and the new EIR would be 3.0485%. In Ontario the 3.0256% is called the cost of borrowing or the APR. The 3.0485% is not mentioned as it is only of concern to the lender. Prior to 2006 the 3.0485% would have been quoted as the Total Cost of Borrowing (TCOB) and the 3.0256% AIR/APR would not have been mentioned.

Before 2006
2.99% 3.0123%
AIR EIR

Because of $250 upfront fees

3.0256% 3.0485%
AIR, EIR, TCOB

After 2006
2.99% 3.0123%
AIR EIR

Because of $250 upfront fees

3.0256% 3.0485%
APR EIR

If there are no up front fees the AIR and the APR are the same.

Click Here to continue to read about The Total Cost of Borrowing which is now known as the Cost of Borrowing.