Annual Equivalent Rate

The Annual Equivalent Rate is a marketing man’s way of bumping up the apparent interest you will earn from investing savings. Unlike APR (Annual Percentage Rate – used in credit), it has no basis in law.

Rather than just quoting the simple interest rate, the Annual Equivalent Rate shows what the total interest return is over one year. So if interest is compounded six monthly, the Annual Equivalent Rate will include the compound interest earned on the interest paid in the first six months. There’s usually not much of a difference compared to the simple rate of interest, but it makes the marketing department feel better about the product.

Be wary that the Annual Equivalent Rate quoted is often the gross one – this means the amount calculated before interest is deducted. By law lenders have to collect tax on the interest earned – known as withholding interest – so the actual amount you receive will be the Annual Equivalent Rate less the basic rate of taxation. If you are lucky enough to be a Higher Rate tax payer, you’ll have to pay the difference to the taxman yourself.

Annual Equivalent Rates must always be compared to other Annual Equivalent Rates. Also note that banks often have the ability to vary interest rates without notice, so unless the Annual Equivalent Rate is quoted as being a fixed one and for a specified period, the amount you receive may differ, either more or less, depending on how rates have moved.

Any interest rate quoted as an Annual Equivalent Raate will only be applicable if you do not withdraw money from your account during the year in question as it illustrates what the interest would be it was paid and compounded (added to the interest from previous payouts). As such, any withdrawals that you make from the account can affect the rate you will receive at the end of the year.

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