APR & AER – Interest rates for borrowing and saving

Posted on February 22nd, 2009

APR, Annual Percentage Rates is the official rate for borrowing.When the annual percentage rate is calculated, it has to incorporate both the cost of the borrowing and any related fees that are automatically included. Therefore, it is calculated to give you the total corresponding cost of a debt.

One of the problems with APR is that It only includes compulsory charges. When getting a new loan many lenders will include payment protection insurance without informing you. This insurance is voluntary and is not included in the APR.
In addition, The APR is intended to specify the amount you will pay each year over the entire term of the debt. In spite of that when the rates change it can become extremely difficult to understand.

The AER or Annual Equivalent Rate is the official rate for savings accounts, and is intended to permit easy comparisons as it is destined to level out the difference between accounts.

It is important to understand the concept of Compound interest when speaking about savings. Compound interest is the process of adding accumulated interest back to the principal, so that interest is earned on interest from that moment on. To put it simpler your money will build faster because you will earn interest on your original deposit but eventually you will also be earning interest on the interest the bank has already paid you. The longer you save the greater effect the compound interest will have on your savings.

If the interest is rewarded yearly then the Gross rate and AER should be the same, as there is no ‘interest compounding’.

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