28.06.2018 | 4 minutes estimated reading time | Print this article

What is AER and how does it work?

In this guide, we’ll explore what AER is, how it’s calculated, and what it means to you as a saver. This guide is part of an ongoing series in which we take a more in-depth look into the nuances of financial services and the savings products available through the Raisin UK savings marketplace.

What is AER?

AER stands for annual equivalent rate, and it’s calculated by combining any interest earned on a savings product during a 12 month period with the amount that you originally deposited. This is known as compound interest.

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 product over each year. Although the gross rate may sound similar to AER, it doesn’t include any compounding (for example, where interest is calculated monthly) and purely reflects the rate at which interest is earned on your original deposit without compounding.

How often is interest compounded?

How often interest is compounded depends upon when a bank calculates interest on a savings product, whether it’s done so daily, monthly or annually. Regardless of how frequently interest is calculated, the AER rate will always reflect how much is earned within a year.

How is AER interest calculated?

Using a savings product with an AER of 1.65% opened with a deposit of £10,000 as an example, we can see how interest is calculated on a monthly basis. As our example bank calculates interest on a monthly basis, we need to divide 1.65% by 12, giving us 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 product will now total £10,013.75.

This process continues as your account matures, but as interest is compounded on an AER savings product, at the end of the second month of maturity your savings product 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.

Is there an easy way to find out how much I’ll earn from an AER savings product?

It’s quite easy to work out how much interest a 1-year fixed term deposit AER savings product will yield, because AER already factors in compounding, so all that you need to do is to multiply your deposit by the AER. The following equations show how much you would earn upon the maturity of a 1-year fixed term deposit of £10,000 deposit with a 1.65% AER:

  • £10,000.00 x 1.65% = £165.00
  • £10,000.00 + £165.00 = £10,165.00

What about 2 and 3-year fixed term deposits?

Although working out how much you’ll earn on a fixed term savings product over multiple years is more complicated, it can be done. You need to factor the annually compounded interest in your calculations, so let’s use our earlier example of £10,000 deposited into a 2-year fixed term deposit with a 1.65% AER, having already earned a year’s worth of interest.

Once you’ve completed the calculations shown above for the first year, you’ll need to work out the next years’ worth of interest, as shown below:

  • £10,165.00 x 1.65% = £167.72
  • £10,165.00 + £167.72 = £10,332.72

Applying the same theory to a 3-year fixed term deposit using the same criteria, you would multiply 2 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 term deposit durations.

Should I check how often interest is calculated?

Most definitely, a gross rate can yield variable returns depending on how often interest is calculated: If two different banks are advertising savings products with a similar gross rate, with one calculating interest on a monthly basis and the other on an annual basis, you’ll see a higher return (AER) on the one calculating interest monthly. This is because of the compounding effect of AER.

Why does Raisin UK show savings products with AER?

We advertise the interest rates of all savings products on the Raisin UK savings marketplace with AER because we believe that AER gives a clearer indication of how profitable a savings product is, making it easier for you to make an informed decision.

If you would like further insight on interest rate calculations before applying for a savings product through our savings marketplace, please contact a member of our Customer Services Team by calling 01616 010 000, Monday to Friday, between 8:30 am and 4:30 pm. You can also send an email to service@raisin.co.uk. We aim to respond to all emails within 2 working days.