What is a Implicit Interest Rate?
An implicit interest rate is an interest rate which is not disclosed in a loan agreement but is implied and can be calculated from the repayment terms of the agreement.
How to Calculate Implicit Interest Rate
Suppose a business has a lease agreement with a lender to borrow 20,000 and has to pay back 22,000 at the end of one year. The interest rate implicit in the lease has not been disclosed in the agreement, but we can calculate the implicit interest rate as being (22,000 – 20,000) / 20,000 = 10%.
While this is a simple example over a one year term, the implicit rate will change depending on whether for example repayments are made monthly or annually, at the start or end of the period, or are regular or irregular. Generally, the implicit interest rate can be shown to be the internal rate of return (IRR) of all the cash flows associated with a loan agreement.
For further information see the Wikipedia implicit interest rate definition.
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About the Author
Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years in all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.