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What is AER?
AER – or Annual Equivalent Rate – can help you to understand how much money you’ll make on your savings account over a year.
AER basics
AER shows you what you would earn in interest on savings over the course of a year as a percentage.
When shopping around for a new savings account, AER can help you to compare different saving or investment options.
It's useful to know that AER accounts for compound interest, which is interest earned in addition to any interest already paid, but it does not account for fees and charges associated with accessing or managing your savings.
AER, interest and savings
When you put money aside in savings, your bank may reward you by paying you interest. That’s usually a percentage of any money you’ve held with them for a full calendar year.
AER represents this. The higher the percentage, the more interest you can expect to earn on your savings.
AER can apply to a wide range of savings products, including:
The amount and regularity of interest payments will depend on the bank or building society, and the terms of the account you select.
Just as an example, fixed ISAs tend to offer higher AER interest returns, but your money may be locked in for longer. Charges or penalties may apply for withdrawing your savings earlier. On the other hand, an instant access ISA gives more flexibility, but lower AER interest returns.
Investments can also be subject to other factors, such as business performance and fluctuations in the stock market, making the potential returns less predictable.
Benefit from tax-free savings by using your yearly Personal Savings Allowance of up to £1,000, and saving up to £20,000 using your yearly ISA allowance.
However you choose to save, it’s important to consider:
- how much tax you might have to pay on any gains
- whether you need regular access to your savings pot
- whether you can afford to lock your savings in to earn a higher AER
- how much risk you’re prepared to accept in the hopes of earning at a higher interest rate.
It’s worth comparing several options to find one that suits your needs best, which is where the AER comes in handy. Whatever you choose, you usually don’t have to do much more than have your money in a savings account to start earning interest.
Understanding the value of an AER
Working out AER can get a little complicated, as it’s influenced by several factors:
- The total (gross) interest earned over a year.
- The effect of compound interest.
- How often the bank pays interest – for example it could be monthly, bi-annually or annually.
You’ll see AER displayed as a percentage – 1.5%, for example. By depositing and holding £100 with a bank offering 1.5% AER, after a year you’d get £1.50.
Just as an example, let’s say you’re able to deposit and hold £2,000 in a savings account offering 2% AER. Accounting for compound interest, your earnings over a 5-year period could look like:
|
Year |
Interest |
Total interest |
Balance |
|---|---|---|---|
|
Year 1 |
Interest £40 |
Total interest £40 |
Balance £2,040 |
|
Year 2 |
Interest £40.80 |
Total interest £80.80 |
Balance £2,080.80 |
|
Year 3 |
Interest £41.61 |
Total interest £122.41 |
Balance £2,122.41 |
|
Year 4 |
Interest £42.44 |
Total interest £164.85 |
Balance £2,164.85 |
|
Year 5 |
Interest £43.29 |
Total interest £208.16 |
Balance £2,208.16 |
You can see that any interest that your bank pays you becomes part of your balance and you start earning interest on the total. Over time, compound interest can help your savings to grow faster.
Advantages and drawbacks of AER
Because it includes the effect of compound interest, AER gives you a realistic view of the interest you could earn. But there are other factors you should bear in mind.
AER gives you a realistic impression of your potential returns on savings and helps you compare savings or investment options.
But AER does not account for any fees or charges related to accessing or managing your savings. It also does not feature alongside all investment products, so investors need to determine the potential returns themselves.
What is the difference between AER and gross interest?
- AER and gross interest both look at the amount of money you can earn on your savings, but not in exactly the same way.
- We've already described how AER accounts for compound interest. The gross interest rate does not. As such, AER is a better way to estimate the potential return on your savings.
- If your bank pays and compounds interest more than once each year, the AER will be higher than the gross interest rate. The more regularly this happens, the greater the difference will be between the AER and the gross rate.
AER and APR – what’s the difference?
When looking at financial products, you might see AER or APR next to an interest rate. Although they’re both shown as a percentage, they represent very different things.
APR (Annual Percentage Rate) is used for loans, mortgages and other forms of borrowing. It indicates the percentage of interest you’ll need to pay each year when you borrow money.
AER (Annual Equivalent Rate) is used for savings and investment accounts. It indicates the percentage of interest you’ll receive each year for having savings with your bank.
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