Annual effective rate

An annual effective rate (AER) is an interest rate that takes into account the effects of compounding. It tells an investor or borrower what annually paid rate would be equivalent to the interest being paid - it is adjusted for the effects of differences in the frequency and timing of interest payments.

The calculation is simple:

AER = (1+ r/n)n

where r is interest rate and
n = number of times an year interest is paid and compounded (e.g., 12 for monthly interest, 0.5 if interest is paid once every two years).

AER allows straightforward comparison of investments and loans that pay interest at different intervals.

Copyright Graeme Pietersz © 2005-2020