APRs, EARs, AERs
October 27, 2007
In all mortgage, loan and credit card documentation these days, the headline rate of interest can be confusing and, to be frank, misleading. The real comparison comes with annual equivalent rate (AER), equivalent annual rate (EAR) or annual percentage rate (APR). But what do these terms mean?
APR is used to measure how much it costs to borrow money, and is used by mortgage, personal loan and credit card providers. The measure includes fees charged up front by the lender, spread over the loan term. It tells you how much you will pay in interest over a year. So if you borrow £1,000 at an APR of 7%, your interest payment for the first year will be £70.
In advertising mortgage lenders show a headline rate and an APR, and the provider usually says “typical APR”. They say this because the actual interest rate they give to a borrower will depend upon their credit record and personal circumstances. However, a bank does have to offer its typical APR (or better) to at least tweo in every three of its customers (otherwise it wouldn’t be typical!). APRs tend to be higher than quoted headline rates because APRs include arrangement fees and the like.
EAR is quoted when you borrow money, this time as an overdraft. However, this doesn’t include fees for going overdrawn, but tells you how much it would cost you if you remained overdrawn for a whole year.
AER is quoted on current and savings accounts. This is similar to EAR but means the interest you earn rather than that you have to pay over the course of a year. This measure enables you to compare what you will earn on an account that pays monthly with one that pays yearly. So you can work out where your savings will earn most. The gross rate paid on an account with monthly interest may look lower than the gross rate on an account offering a single annual interest payment, but when interest is compounded the monthly account may give higher returns than the annual account.
If there is a charge for taking your money out, then the AER will take this into account. As an example, if you are charged 30 days’ interest for a withdrawal, this must be accounted for in the AER.
If an account includes an introductory bonus for a period, this may or may not be included in the AER, but you should be told.