What is AER, and how does it work?

AER is a common financial acronym that’s often seen alongside savings account interest rates in the UK. But what does AER mean? Here, we cover the basics of what AER is, how it’s calculated, how it’s different to other interest rate calculations, and what it means to you as a saver. You’ll find all the savings accounts advertised in our marketplace are displayed with the AER, allowing you to quickly and easily compare products with different terms.

In the UK, AER stands for Annual Equivalent Rate. You may also see an interest rate listed as an Effective Annual Rate (EAR) or Annual Percentage Yield (APY), which are similar ways of calculating interest, but are used in different contexts.

AER is the interest rate most commonly used to make comparisons between savings accounts and investments, because it allows you to see how much interest you’ll earn over a full year. This calculation takes into account the effects of compounding, but doesn’t include bonuses or bank charges.

So what is AER interest used for exactly? The AER makes it easier to compare savings accounts in the UK by illustrating how much interest you could earn from a savings account if it were open for one year, regardless of the term or type of savings account. Generally speaking, the higher the AER, the greater the return on your money.

The AER is sometimes confused with the gross rate. The gross interest rate, or gross rate, is the basic annual rate of interest paid on a savings account. 

Although the gross rate may sound similar to the AER, the gross rate does not account for compounding. It simply shows the amount of interest you’ll earn on your money each year before any tax deductions.

The gross rate is typically lower than the AER when interest is paid monthly, because AER interest includes the effects of compounding. If interest is paid annually, however, the gross rate and the AER might be the same, as there’s no additional compounding within a single year.

The AER is generally the more effective way to compare savings accounts, as it reflects the true annual return on your money. However, remember that AER interest doesn’t tell the whole story when it comes to saving. Savings interest is treated as income for tax purposes, so your final gains may be lower, unless the money you earn falls within the Personal Savings Allowance.

Compound interest is the interest you earn on the value of your original deposit combined with any interest you’ve already received. In other words, it’s interest that’s paid on your original balance plus interest. It might sound like a riddle, but compounding can be a very effective way to grow your savings over time. Not all savings accounts offer compound interest, so it’s worth checking the details of a savings account before you apply.

How often interest is compounded depends upon the bank offering the savings account. You may see a savings account advertising that ‘interest is calculated daily, compounded annually, and available on maturity’. This means the bank is checking your balance and accruing interest daily, but it is paying you that interest once a year and making the whole sum available to you at the end of the fixed term.

Regardless of how frequently interest is compounded, the AER always illustrates what you could earn within a year if interest is compounded annually.

Calculating the annual equivalent rate will allow you to work out exactly what’s happening with your savings. To calculate AER interest, divide the gross interest rate by the number of times per year that interest is paid on your account, and add one.

You then raise the result to the number of times a year interest is paid. Subtract one from that result and you’ll be left with the AER. An example of this calculation is explored below.

The AER formula is quite complicated, which is why we do the calculations for you to show how much you’ll earn from any savings account on our marketplace. If you want to do the maths yourself, it’s easiest to start with a one year fixed rate bond which pays interest annually, as all you need to do is multiply your deposit amount by the AER.

The following equation shows how much you would earn when your one year fixed term deposit of £10,000 with a 5.00% AER matures:

£10,000 x 5% = £500

£10,000 + £500 = £10,500

Working out how much cash you’ll earn from fixed rate bonds with terms other than one year, or if interest isn’t paid annually, is a little more complicated. You can use the following five steps to work it out yourself:

1. Start by finding out the gross interest rate

2. Divide the gross interest rate by how many times interest will be paid in a year

3. Add one

4. Raise the result to the number of times interest will be paid in a year

5. Subtract one

You can use the AER formula to work out how much interest you’ll earn from 2 year fixed rate bonds, 3 year fixed rate bonds, and fixed rate bonds with other terms. The good news is that at Raisin UK, we do the maths for you so you can see how much you could earn from a savings account before you apply.

It’s always worth ensuring that you fully understand how a savings account works before you apply for it, but it’s especially important to check how interest is being advertised. A bank in the UK should always advertise the gross rate of interest as well as the AER, and while these percentages can be the same, they could be different. If you compare savings accounts from two different banks, but you compare the gross interest rate from one account with the annual equivalent rate from another, you may end up with a misleading comparison.

AER variable means that your savings account provider can change the interest rate of your savings account. A savings account provider should advertise how much notice they’ll give you of a rate change. If the rate is variable, it means that it could increase or decrease.

EAR stands for ‘equivalent annual rate’, and it’s similar to the AER, but rather than showing how interest will be calculated for a savings account, the EAR is used when displaying interest rates for lending, such as loans, mortgages, credit cards, and overdrafts. You might be more familiar with the term APR, or annual percentage rate. Like the EAR, APR reflects the cost of borrowing money, including interest and fees, but doesn’t account for compounding (unlike the EAR).

APY stands for ‘annual percentage yield’, and it acts in a similar way to the AER, in that it factors in interest being calculated at multiple stages during a savings accounts term, giving you a clearer picture of how much interest you’ll earn. The APY is more commonly used in the USA, whereas the AER is more commonly used in the UK.

We display the interest rates of all savings accounts on the Raisin UK savings marketplace with the AER because it makes it easier to compare the profitability of savings accounts, so you can make an informed decision.

You may also see Islamic savings accounts advertised with an EPR, or ‘expected profit rate’. That’s because Sharia law doesn’t allow you to earn interest in the same way as traditional banking. Instead, Islamic banks will pay you from profit that is made during the year, rather than from interest.

Our aim is to make choosing and opening a savings account as easy as possible. That’s why we give you the ability to apply for savings accounts from different banks and building societies in just a few clicks.

Simply register for a free Raisin UK Account through the website or via our app to apply for the best savings account for you, compare savings accounts, or look for a partner bank.