AER stands for ‘Annual Equivalent Rate’ is used for savings and it shows the rate of interest a saver will receive over a year assuming the cash is left in the account for the full year. Its aim is to demonstrate what your interest return would be if the interest was compounded and paid annually instead of monthly or any other period.
It’s actually very easy to calculate what your savings will be worth in one year if you know the AER. For example:
Starting Amount = £1,000
Time = 1 year
AER: 5%
Total Balance at the end of the year = £1,050
You simply multiply the original amount by the AER to calculate what your savings will be worth in 1 year.
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 monthly, the AER will be slightly higher than the quoted gross rate because of the compound interest earned on the interest paid during the year.
The difference will usually be very small (less than 0.1%) which amounts to less than £1 per £1,000 in savings, so not particularly important. However, if you have large savings then this is a different matter as even small percentage differences can amount to several hundred pounds in extra interest over the year. This is why people who normally use their savings to fund their retirement tend to opt for savings accounts that pay monthly.
Useful Links
>>> Savings Accounts explained
>>> Other Money Jargon explained
>>> Cash ISAs
