AER stands for Annual Equivalent Rate.
At Shawbrook, we’ll always let you know a savings account’s AER. You may see other providers describe their interest rates as Effective Annual Rate (EAR) or Annual Percentage Yield (APY). EAR and APY are similar but are not the same.
As we like to keep things simple, we want all our savers to understand the interest rates we offer. In this guide, we’ll explain everything you need to know about AER — what it is, how it differs from gross interest and APR (annual percentage rate), and how interest is calculated.
AER is the interest rate that shows how much you’ll earn in interest over an entire year. The AER calculation considers how often you’ll be paid interest (i.e. monthly or yearly) and includes bonuses, compound interest, and any account charges made for allowing early withdrawal of money.
As AER considers these elements, it gives an accurate view of the interest you’ll earn. And because of this, it’s simple to compare different savings accounts. With AER, you’ll see how much you’ll earn from each account if open for twelve months and can compare yearly interest rates regardless of the account’s term or type.
The gross rate is the interest rate without the deduction of income tax. This is the interest rate paid on your account.
So, how does this differ from the AER?
The gross rate, or gross interest rate, is the rate you’ll get when you first open a savings account. AER shows how much you’ll earn over a whole year.
The gross interest rate is a flat rate of interest that doesn’t take compound interest into consideration. Compound interest is when you earn additional interest on previously earned interest. For example, if you’re paid interest monthly, your account balance will increase each month. The interest earned the next month will be based on your new balance, not your original deposit.
Gross rates include bonuses, but they only show what you would earn at the outset. This means that if a bonus is an introductory offer and lasts less than one year, the rate does not show what happens when this ends. They don’t consider how much you would make by keeping your savings in the account for a longer period.
If two accounts have the same gross rate but have different AERs, the account with the higher AER will pay more interest. The higher the AER, the greater the return.
To put it simply, APR is usually used to refer to what you pay back, while AER is the interest you will be paid. Both are expressed as percentage figures.
Shawbrook and other banks will provide the AER on savings accounts. You don’t need to work out the AER interest, but understanding the formula used to calculate AER can be useful.
The formula for AER is AER = (1 + i/n)^n − 1.
‘i’ represents the annual interest rate as a decimal, while ‘n’ is the number of times the interest is paid throughout one year.
Don’t worry if you’re confused. You can break down the formula into these simple steps to see how AER is calculated:
If you were to choose a savings account with an interest rate of 5% that paid all interest once at the end of each year, your AER would be 5%:
5% AER = (1 + 0.05/1)^1 − 1
If you invested £500, you would finish the year with £525.
But gross interest rates and AER are only the same if interest is exclusively paid once annually. For example, an account with an interest rate of 2.5% that paid interest twice a year would have an AER of 5.06%:
5.06% AER = (1 + .025/2)^2 − 1
If you invested £500 in that account, you would end the year with £525.30.
You may have assumed the account with a 5% gross interest rate would pay more than the account with 2.5%. But the 2.5% interest rate account will earn more because of compound interest. That’s why it’s essential to use AERs to compare, not gross interest rates.
Now that you know more about AER, you can make a better-informed decision when investing your money.
To compare the interest rates you could receive with Shawbrook, visit our main savings page.