# Effective Interest Rate Definition

Answer:
The **effective interest rate**, also called **annual equivalent rate (AER)** is the converted rate allowing to compare different loan programs. Since interest rates may be
calculated on different compounding terms (daily, monthly, weekly, quarterly,
annually, etc.), the effective interest rate formula is in fact converting
rates based on different compounding periods to annual ones and makes loans
better comparable.

The effective interest rate is not the same as the annual percentage rate (APR) as it does not incorporate one-time costs associated with the loan as APR does.

The effective interest rate will be calculated with the formula:

**effective interest rate = (1+i/n) ^{n}-1 **

where *i* is the nominal rate, and *n* is the number
of compounding periods.

For example, a nominal interest rate of 7% compounded quarterly will be calculated as:

effective interest rate = (1+0.07/4)^{4}-1 = 0.07185.

Or, the effective annual interest rate will be 7.185%.

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