What is AER, and how does it work?
AER is a common financial acronym that’s often seen alongside savings account interest rates. 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.
Table of Contents
- What does AER stand for?
- What is AER interest?
- What's the difference between AER and gross interest rate?
- What is compound interest?
- How do I work out how much I'll earn from a savings account?
- Should I check how interest is advertised?
- What does AER variable mean?
- What are EAR and APY?
- Why does Raisin UK advertise savings accounts with the AER?
What does AER stand for?
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 that are used in different contexts.
What is AER interest?
It’s not unheard of for even experienced savers to question “what does AER mean?”, so don’t worry if you don’t know. 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.
What's the difference between AER
and gross interest rate?
The gross interest rate, or gross rate, shows the actual or ‘effective’ annual rate of interest on a savings account over each year. Although the gross rate may sound similar to the AER, the gross rate reflects the contractual rate, meaning that it takes into account any contractual terms and conditions that could affect the rate of interest you could earn in a year, including any compounding.
The gross rate may be higher or lower than the AER, but the AER makes it easier to compare savings accounts.
You may also see the terms ‘simple gross rate‘ or ‘gross simple‘. These terms mean that the interest rate doesn’t include compounding.
What is compound interest?
The interest you earn from a savings account could be paid to you as you earn it or at a later date, or it could be paid back into your savings account, from which you could earn interest from your original deposit, as well as on any interest you’ve earned. This process is known as compounding. Not all savings accounts compound interest, so it’s worth checking the details of a savings account before you apply.
How often is interest compounded?
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.
How do I work out how much I'll earn from a savings account?
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 1.65% AER matures:
£10,000.00 x 1.65% = £165.00
£10,000.00 + £165.00 = £10,165.00
Working out how much 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:
- Start by finding out the gross interest rate
- Divide the gross interest rate by how many times interest will be paid in a year
- Add one
- Increase the result by how many times interest will be paid in a year
- Subtract one
You can use this method 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, but at raisin.co.uk, we do the maths for you so you can see how much you could earn from a savings account before you apply.
Should I check how interest is advertised?
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 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 AER from another, you may end up with a misleading comparison.
What does AER variable mean?
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.
What are EAR and APY?
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, credit cards and overdrafts.
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.
Why does Raisin UK advertise savings accounts with the AER?
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.
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