What is an effective annual interest rate?

The term “effective annual interest rate” concerns the actual return on the investment, taking into account the effect of the composition of the periodic interest. Effective annual interest rates are only important when considering investment possibilities, which are considered very safe, because the invested principal does not change and growth is mainly due to or only because of the attribution of interest at a predetermined rate. The rates themselves are important for investors who are considering various investment opportunities that have different rules for composing or attributing interest. Another system, which is called a simple interest, does not add interest payments to the director, but usually pay it directly to the account owner. Exceptions to the composition of interest are investing in long -term bonds, most of which pay simple interest and provide periodic interest checks to bond holders, while their account balances remain static.

Consumers buy safe investments whose growth comes from periodic combination of interest payments, should be very effective at an effective annual interest rate, as it is a better real -rate indicator than the annual interest rate statement. In the United States, for example, most of the deposit certificates (CD) of one -year or less interest pay only once, after maturity, unless otherwise stated. However, some CDs and other savings plans calculate the interest gained at the end of each month or quarter.

However, if two annual CDs offered the same interest rate, but one paid it as a simple year at the end of the year and the other complicated and attributed interest per month would be the other better investment, because the interest received after the first month would be calculated not only for principal but also interest.

For example, an annual CD of $ 10,000 (USD), which pays 10% simple interest, receives an interest of $ 1,000 per maturity. The same $ 10,000 invested in the savings account,which pays 10% composed per month, gains interest for a measure of $ 0.833% per month, ie $ 83.33 at the end of the first month, $ 84.03 at the end of the second month and thus at the end of the 12th month, until the end of the 12th month reached $ 1047.13. If $ 10,000 was placed on an account that consists daily, the first day of the day would be $ 2.74 and the total interest of 365 days would be $ 1051.56 for an effective annual intestal rate of $ 10,5156%

Increase the number of periodic interest payments will increase the effective annual interest rate, and therefore this concept is important for investors, especially for those looking for safe, short -term savings products.

Another frequently used term “annual percentage rate” or APR is used to provide debtors to a reference framework for comparing interest rates charged from loans. It is calculated in a different way because in most cases they reduce regular loans payments for a lower loan; Fees and other loan fees may include the calculation.