OK, suppose you have $100 and you deposit this in a bank that pays an interest of 10% once a year. In this example, you would have earned 0.10 x $100 = $10 after one year. This is equal to a return of 10/100 = 10%. In this example, the quoted interest rate (APR) is equal to the effective interest rate. Now if the bank pays you interest twice a year instead of once a year, after six months, you will be paid $5.00. (100 x 0.10/2)=$5.00. That leaves you with $105 after six months. At the end of the year, you will get $105 x (0.10/2) = $5.25. So for the whole year, you would have earned $10.25, giving you a return of 10.25%. Your effective rate is higher than the quoted rate because you were paid interest semi-annually. The compounding effect was working in your favor. In the case of a loan or credit card debt, the reverse happens. You pay interest and principal once a month instead of once a year like in the above example. Your effective rate is definitely higher than the quoted APR. OK now let's talk about a line of credit. By depositing your income into a balance you already have on a line of credit, you lower the average daily balance of that loan. Which means, less interest is charged. (Since interest is charge on an average daily balance) If you pay less interest you are reducing your cost to borrow that money. Effective interest rate (as seen in the above examples) takes into consideration the true cost to borrow the money. If you lower your costs to borrow, you lower your effective rate. The same applies to the 1st mortgage... If you can make additional principal payments to your 1st mortgage, you are paying less interest in the long run. If you pay less interest, then you lower your cost to borrow that money. The effective rate in the software calculates just the mortgage but I will show you how it works in a line of credit to simplify things Without the software, let's assume that in a LOC, on a balance of $10,000 it costs you $1,000 a year to borrow that money well, that will tell us that the APR is 1,000 = 10.00% 10,000 But now let's say that by depositing our income into the LOC allowed us to have a cost of $300 a year to borrow the $10,000 The effective rate in this scenario would be 300 = 3.00% 10,000