What is AER?

Revolut Contributor

 · 05/20/2020  · 05/20/2020

What is AER? What is the AER interest rate? And what’s the difference between AER and APR? These are all good questions, and we hope to answer each one in this blog post.

What Does AER Mean?

To define the AER meaning quickly: the Annual Equivalent Rate is the interest rate used for fixed deposit accounts.

Different banks pay out interest on savings products at varying degrees of frequency. The AER exists to tell you how much you will earn in a complete year, depending on how many times in that year your investment pays out.

Is AER Paid Monthly or Annually?

Interest will be paid out in accordance with the agreement you’ve got with your financial provider. The AER allows you to work out what the total interest that you earn in a year will be.

Understanding Compound Interest

“Compound interest” is an important concept to understand when it comes to managing your money effectively – and it lies at the heart of how AER is calculated.

It takes into account the interest you’re paid on the original amount you’ve invested, as well as the interest you make on the interest you earn.

  • Let’s say you put £100 in a savings account and you earn 1.5%* interest a year.
  • After the first year, you’ll earn £1.50 in interest.
  • This means that your total savings will now be £101.50.
  • The next year, you’ll earn 1.5% interest on your new total of £101.50.
  • 1.5% of £101.50 is £1.52.

*Figure for illustrative purposes only

So, the total of your savings for the second year will be £103.02

Make sense?

Now let’s return to AER interest and how it’s calculated. Here’s where it gets tricky, as the interest you receive may be compounded more frequently than once a year.

How to Calculate AER

AER is calculated by factoring in three key factors:

  1. The amount of gross interest earned in a year
  2. The number of times interest is paid annually
  3. That the interest you earn is compounded
The AER formula is [(1 + i/n)^n] - 1

‘i’ is the annual interest rate and ‘n’ is the amount of times in the year interest is paid.

Now, if just looking at that formula gives you anxiety, don’t worry. Let’s break it down:

  1. Take the total (or gross) interest rate that will be paid over the year. (That’s your ‘i’ in the formula).
  2. Divide it by the number of times the interest will be paid out in a year (if your bank pays interest every 3 months. Your ‘n’ will be 4).
  3. Then, add 1.
  4. Raise your total to ‘n’ (or 4 in our previous example).
  5. Finally, subtract 1 from this total.

What does that look like in the real world? Let’s explore.

What does 1.5% AER mean?

If your bank gives you an AER of 1.5%, it means that you will earn approximately 1.5% on your investment in one year.

  • Let’s again say that you put £100 in a savings account at the beginning of the year.
  • Your bank’s AER is 1.5%. That means by the end of that year, you will earn approximately 1.5% (or £1.50) in total interest.

That 1.5% you receive at the end of the year will take into account:

  • How much interest you earn when compounding is taken into consideration
  • How many times a year your investment earns interest.

What is the Difference Between AER and APR?

APR stands for Annual Percentage Rate.

While AER is concerned with interest you‘ll earn, APR calculates what borrowers owe to investors in terms of borrowing fees and other costs incurred through loans.

Expressed as a percentage, the main purpose of the APR is to give consumers the information they need to compare lenders. Another major difference between AER and APR is that APR does not factor in compounding.

We hope we’ve explained what you need to know about AER. Check out our related blog posts below: