AER - Annual Equivalent Rate

The AER - Annual Equivalent Rate - is a notional rate that's generally quoted on interest paid on savings and investments. It purports to demonstrate what your interest return would be if the interest was compounded and paid annually instead of monthly (or any other period).

If an account pays interest more than once a year, say, for example, monthly or quarterly, then the AER is calculated by adding each interest payment to the deposit and then calculating the next interest payment, compounding the interest. Thus, on accounts where interest is paid quarterly, the AER will be slightly higher than the quoted gross rate because of the compound interest earned on the interest paid during the year.

All advertisements for interest-bearing savings accounts quote AER, allowing you to compare the kind of return you may expect to get. However, you should remember that the AER is only a notional rate and will not necessarily reflect the cash return you will get since certain assumptions are made in its calculation.

The gross AER is the contractual rate of interest payable before the deduction of income tax. Net AER is the amount of interest payable after allowing for the deduction of 20% tax for basic rate taxpayers.

The AER quoted may include or exclude any bonus interest that may be payable. Be sure you are comparing like with like.

See also: Annual Percentage Rate (APR) Loans and credit cards centre

Last Updated: April 2008 © Moneyextra.com

MoneyExtra.com recommends you should consider taking independent financial advice before acting on any article. Please contact us for help with your individual circumstances if any assistance is required.