What is AER? Understanding the annual equivalent rate

The article was updated on 31.12.2024

What is AER, and why does it matter in the financial world? AER stands for annual equivalent rate, and it’s a crucial term in personal finance management. Once you understand what is and how it works, you’ll be in a better position to make the most of your savings accounts and other investments,

As part of our role as a financial institution facilitating comprehensive business account services and information, Genome is here to answer all these questions and more! By reading on, you’ll get a clear understanding of the interest rate mechanism and how it allows you to compare savings accounts to make good decisions.

What is the annual equivalent rate (AER)?

The annual equivalent rate is a figure that shows the amount of interest earned on a savings account over an entire year. You might also see a different name for it – the annual percentage yield (APY), which is commonly used in the US.  

So, if your account earns 10% AER that is paid annually and you have £100 in it, you would expect to see £10 in interest at the end of 365 days. In this example, we can see how using the AER gives a clear answer to how much is earned in interest payments. 

If the interest is paid more regularly, it boosts your balance through compounding, and this interest rate accounts for all the compounding that takes over a year. It is important in those cases where interest is compounded more than once a year, as it means that the AER is a more accurate figure for the interest earned than the nominal interest rate. 

How AER works

We can see what AER is by looking at how AER and gross interest are calculated on a business account / personal account. It gives the most accurate view of savings account compound interest numbers. 

Calculation of AER

The basic formula for AER interest rate calculations is as follows: ​

Annual equivalent rate==(1+r/n)ⁿ -1

In this calculation, n is the total number of compounding periods. In other words, the number of times interest is paid into the savings account each year. If it pays interest annually, this is 1. If it pays interest quarterly, it will be 4, and so on.

Meanwhile, r is the nominal annual interest rate for the account.

AER vs. gross interest rate

How do the AER and the gross interest rate vary, and why does this help you with calculating interest on different savings accounts?

The stated gross rate might be higher on a certain account, but the compounding effect seen in the AER could make an account with a lower stated rate better for you. Let’s say you get 4% interest paid annually. It gives you an AER of 4%.

Yet, an account with a stated interest rate of 3.95% paid quarterly has an AER of 4.02%. So, it’s slightly better for you even though the starting rate is lower. The answer to the question ‘what is AER’ in this case is that it’s a more accurate representation of the interest amount. 

Impact of compounding frequency

How does this work to boost your interest rate simply by getting interest more times during the year? The key is that you earn additional interest on the interest that’s already paid to you rather than waiting until the end of the year for it.

• If you have £10,000 in an account that has 4% interest annually, you get £400 at the end of the year.
• However, if it’s paid quarterly, you get £100 after the first quarter, and that money starts earning interest, too. This means that the interest starts adding up more rapidly through compounding, which is shown in the annual equivalent rate.

Benefits of understanding AER

Understanding AER will help you determine which interest rate is better for you and which savings accounts suit you best. But what else can we see in terms of the benefits?

Enhanced financial planning

When you understand the gross interest rate, it allows you to clearly work out how much you’re going to earn each year in interest payments. It is a way of planning more carefully because you know exactly what your savings account provider will be giving you, so you can work out how much you will have, how much tax to pay, etc. 

Comparative tool for savings accounts

The biggest benefit is being able to compare interest rates accurately, thanks to the annual equivalent rate. As we saw in the examples, a lower interest rate might work out better for you if the interest payment is made more than once a year. 

Maximizing savings potential

Once you understand the way interest payments work on AER accounts, you can see how getting interest compounded helps you enormously. By getting paid interest frequently, you’ll see how a savings account works to your benefit by paying interest on the interest already earned.

Transparency in interest earnings

The gross rate reflects the amount of interest paid in percentage terms, but it isn’t always clear how much that means in cash. By seeing exactly how you earn interest when you calculate AER rates, you can understand the earning power of your money by considering the savings accounts’ compound interest potential. 

Decision-making confidence

You can make decisions with confidence after calculating AER amounts and seeing the difference between AER on various accounts. Understanding the AER variable or fixed rate means you can decide between the different banks offering you savings rate, and feel reassured you’ve made a good decision.

Genome’s role in financial planning

Good financial planning also depends on how reliable your financial provider is. And Genome can certainly help with that, as we provide financial services for personal and business wallet users. By turning to Genome, you’ll get a variety of instruments to streamline and track your financial transactions, from multi-currency accounts to multiple Visa cards!

Our robust approach to financial management is supported by a strong focus on security and extended features that make it easier for you to feel safe.

With a dedicated IBAN account, you can make and receive Instant and Credit SEPA Transfers. 

Additionally, you get the option of opening accounts in 11 various currencies. 

Business debit cards allow you to stay in control of your money as you travel across the planet, while batch transfers give you a fast and efficient way of dealing with a large number of transfers.  

Practical considerations when evaluating AER

When you’re evaluating AER and seeing how much interest you could earn, it’s important that you read the contractual terms to understand the key factors. How much interest is paid each year and how much notice you need to give for withdrawals are two of the most crucial questions you need to ask. Is there a savings account term to comply with, or does making a withdrawal affect your next internet payment?

Don’t forget to take into account taxes on the amount of interest you could earn. When interest is paid grossly, you need to work out tax liability liabilities, calculated based on your earnings, unless you have tax-free savings.

Manage your finances with a greater degree of clarity

“What is AER?” – a question easily answered now, as it lets us calculate the exact interest rate offered by savings accounts. Understanding how to calculate the annual equivalent rate is important when comparing savings accounts, as AER and gross interest can give different amounts.

You should consider using Genome’s comprehensive online services for enhanced financial management and planning. Our range of money transfer options, accounts, cards, and other features make it easier for you to manage your funds wisely and without any hassle.

Now that you have a clearer idea of how to use AER, you can calculate more accurately how much interest you will earn and use that information to plan to carry out activities like implementing an expansion, borrowing money, or paying back loans.    

FAQs

Is AER the same as APR (Annual Percentage Rate)?

No, AER (annual equivalent rate) tells you exactly how much interest you’ll receive from a savings account in a year. APR tells you the cost of borrowing, taking into account issues such as fees. Both give accurate figures, but for other interest rate calculations.

How is AER different from the nominal interest rate?

What is AER that makes it more accurate than the nominal gross interest rate on savings accounts? With AER, we take compound interest into account. It’s an accurate way of calculating the gross rate. The only time both types would be the same is when interest is paid annually. 

Does AER account for fees or charges on savings accounts?

No, this calculation takes into account the gross rate of interest and the number of times a year interest is paid to work out an equivalent annual rate. You need to work out the effect of any fees or charges separately.

Can AER change over time, and if so, why?

Calculating AER is based on the current interest rates and how many times a year compound interest is paid. If either of these factors changes, the amount of AER and gross interest earned will change, too.

What factors should I consider besides AER when choosing a savings account?

AER and the latest interest rates aren’t the only factors to consider. You’ll also want to see whether any monthly fees or transaction fees are charged. Take a look to see whether the range of banking services is right for you in terms of areas like bank cards and international transfers.

Does a higher AER always mean a better savings account?

This figure lets you see the effect of compound interest on the interest you earn. The higher the AER, the more interest you get paid. However, this is just one area to consider when looking at savings products, as it doesn’t tell us everything about the quality of service and range of products.