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.
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. AER is how interest is calculated for savings accounts in the UK. AER is calculated by compounding any interest you earn from a savings account during a 12 month period. Because AER shows how much interest you would earn from a savings account if it were open for a year, regardless of the term of the savings account you want to apply for, it makes it easier to compare different types of savings accounts.
What's the difference between AER
and gross interest rate?
The gross interest rate, or gross rate, shows the notional annual rate of interest on a savings account over each year. Although the gross rate may sound similar to AER, the gross rate purely reflects the rate at which interest is earned on your original deposit without compounding any of the interest you earn.
This means that if there’s more than one compounding period, the gross rate will typically be lower than the AER. The AER gives you a clearer picture of how much interest you’ll actually earn compared to the gross rate.
What are EAR and APY?
EAR is similar to AER, but rather than showing how interest will be calculated for a savings account, EAR is used when displaying interest rates for lending, such as loans, credit cards and overdrafts.
APY acts in a similar way to AER, in that it factors in interest being calculated at multiple stages over the course of a savings accounts term, giving you a clearer picture of how much interest you’ll earn. APY is more commonly used in the USA, whereas AER is more commonly used in the UK.
How often is interest compounded?
How often interest is compounded depends upon the savings account provider and when they calculate interest on a savings account, whether it’s done daily, monthly or annually. Regardless of how frequently interest is calculated, the Annual Equivalent Rate always reflects how much you’ll earn within a year.
How is AER interest calculated?
The AER formula, or how AER is calculated, combines the interest you earn on a savings account with the amount of your original deposit.
If you were to open a savings account with an AER example of 1.65% and a deposit of £10,000, you can see how interest is calculated on a monthly basis by using some basic maths. If the bank calculates interest on a monthly basis, you need to divide 1.65% by 12, giving 0.1375%. After a month of maturity, a deposit of £10,000 would earn 0.1375%, which works out to be £13.75. This means that your savings account will now total £10,013.75.
This process continues as your account matures, but as interest is compounded on an AER savings account, at the end of the second month of maturity your savings account would earn 0.1375% on your deposit and the interest earned so far. This means that you would earn 0.1375% on £10,013.75, giving you £10,027.52, and so on each month.
How do I work out what I'll earn
from an AER savings account?
It’s quite easy to work out how much interest you’ll earn on a one year fixed rate bond. As AER already factors in compounding, all you need to do is multiply your deposit by the AER.
The following equations show 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
What about two and
three year fixed rate bonds?
Working out how much you’ll earn on a fixed rate bond over multiple years is a little more complicated as you need to factor the annually compounded interest into your calculations.
Using our earlier example of £10,000 deposited into a two year fixed rate bond with a 1.65% AER, you already know that there’s £10,165.00 in your savings account after the first year of your term.
Now you need to work out the second year’s interest:
£10,165.00 x 1.65% = £167.72
£10,165.00 + £167.72 = £10,332.72
Applying the same theory to a three year fixed rate bond and using the same criteria, you would multiply two years of compounded interest by the AER rate again:
£10,332.72 x 1.65% = £170.49
£10,332.72 + £170.49 = £10,503.21
This method can also be applied to other fixed rate bond durations.
Should I check how often interest is calculated?
It’s worth making sure that you fully understand how a savings account works before you apply for it, but it’s especially important to check how interest is calculated if the interest rate is shown as gross rather than as an AER. If two different banks advertise savings accounts with the same gross interest rate, but one calculates interest on a monthly basis and the other on an annual basis, you’ll see a higher return on the one calculating interest monthly. This will be factored into the AER but not shown by the gross rate.
What does AER variable mean?
AER variable means that your savings account provider can change the interest rate on your savings account. A savings account provider should advise you of how much notice they’ll give you of a rate change, and if the rate is variable, it means that it could increase or decrease.
Why does Raisin UK show savings accounts with AER?
We advertise the interest rates of all savings accounts on the Raisin UK savings marketplace with AER because we believe it gives a clearer indication of how profitable a savings account is, making it easier for you to make an informed decision.
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