What is the effective annual rate (EAR)?

The EAR is the rate of interest earned in a year, taking compound interest into account. It is also referred to as the effective interest rate, the effective rate, or the annual equivalent rate (AER).

Where have you heard about EAR?

You will often see the EAR included in information about investments, loans or other financial products.

What you need to know about EAR.

When comparing products that calculate compound interest differently, you can use the EAR to work out which financial product attracts more interest over the course of the year. For example, one company may pay or charge 5% interest compounded each month while another pays or charges 7% interest compounded every quarter. Use EAR to work out which product is more advantageous to you.

The formula for EAR is as follows:

(1+(nominal rate / number of compounding periods)) ^(number of compounding periods) – 1

If an investment that pays 20% compounded every 6 months (1+(20%/2)^2-1 = 0.21%

Because the EAR takes compounding into consideration, it is usually a higher rate than the stated annual interest rate.