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%.
Final piece of advice: Monitor your credit report and score regularly, to ensure there are no inaccuracies or unauthorized activity. Your credit report and score are the two major methods that creditors and lenders use to make a credit decision about you. Higher scores usually mean lower interest rates, which will save you money.
See All 3 National Credit Scores & 3 Reports Instantly, Online & Free!
| Not at all | Definitely |
Mortgage QnA is not a common forum. We have special rules:
- Post no questions here. To ask a question, click the Ask a Question link
- We will not publish answers that include any form of advertising
- Add your answer only if it will contrubute to the quality of this Mortgage QnA and help future readers
Common misspellings: mortage and morgage