Factsheet APR AER and EAR
Below is a MRR and PLR article in category Finance -> subcategory Loans.
Factsheet: Understanding APR, AER, and EAR
When dealing with loans and mortgages, some lenders opt for hefty upfront fees paired with low interest rates, while others charge low fees and high interest rates. To navigate these options, you need to understand key measures like the Annual Percentage Rate (APR), Equivalent Annual Rate (EAR), and Annual Equivalent Rate (AER).
What is APR?
The Annual Percentage Rate (APR) is a tool used to measure the cost of borrowing money. It’s commonly quoted by mortgage providers, as well as companies offering personal loans and credit cards. The APR includes upfront fees charged by the lender, distributed over the borrowing period.
APR tells you how much your borrowing will cost annually as a percentage of the loan amount. For example, if you borrow $100 at an APR of 9%, you will incur $9 in interest and fees over the first year.
Mortgage ads typically display both a headline rate and an APR. The typical APR indicates the rate offered to at least 66% of potential customers based on their credit profile. It's worth noting that administration fees are often included, making APRs higher than headline rates.
What is EAR?
The Equivalent Annual Rate (EAR) is used when discussing overdrafts. Unlike APR, EAR does not factor in fees for overdrawing. It reflects how much it would cost if you remained overdrawn for a full year, taking into account the interest rate, its frequency, and the effect of compounding (interest on interest).
What is AER?
The Annual Equivalent Rate (AER) is used for savings and current accounts when your balance is in credit. Similar to EAR, AER focuses on interest earned rather than paid. It shows how much interest you will earn in a year, accounting for compounding and the frequency of interest payments.
AER allows you to compare different accounts, such as those paying monthly versus annually. Even if an account offers a lower gross rate with monthly interest, compounding could result in higher returns compared to an account with annual interest.
Example
Consider an account offering 6.25% interest annually versus an account providing 6.12% with monthly payments. The AER for the monthly account might actually be 6.29%, surpassing the annual interest option at 6.25%.
In cases where withdrawals incur fees, such as a 30-day interest charge, the AER reflects this. Also, if an account includes an introductory bonus, the AER indicates whether this is factored in, allowing you to make fair comparisons with accounts offering consistent interest rates throughout the year.
These measures, APR, EAR, and AER, are crucial when comparing financial products, ensuring you understand the true costs and benefits of borrowing and saving.
You can find the original non-AI version of this article here: Factsheet APR AER and EAR.
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