922Explanation of the AER
923The following provides a simple explanation of the AER which is intended for distribution to
924staff and/or customers.
928The Annual Equivalent Rate is a notional rate quoted in advertisements for interest-bearing
929accounts which illustrates the Gross Interest Rate (excluding any bonus interest payable) as
930if paid and compounded on an annual basis.
933Advertisements may also quote an AER including conditional bonuses clearly identified as
936 • If an account pays or credits interest once a year, then the AER is equal to the gross
939 • If an account pays interest more often than once a year, then the AER is calculated
940 by adding each interest payment to the deposit and calculating the next interest
941 payment on the total – compounding the interest.
943For example, an account offering 5% gross interest paid quarterly on £100 pays:
945 • £1.25 (1.25% (¼ of 5%) of £100) after 3 months,
946 • £1.26 (1.25% of £101.25 (£100 + £1.25)) after six months*,
947 • £1.28 (1.25% of £102.51) after nine months, and
948 • £1.30 at the end of the year (1.25% of £103.79),
950giving a total including interest of £105.09.
954*In practice, the calculation is worked to more decimal places to avoid rounding errors.
956 • If an account pays interest at intervals greater than 1 year, we are looking for a rate
957 which will give us the right answer if applied and compounded each year.
959For example, an account which pays 5% for five years but pays it only at the end of the five
960years will pay back £125 after the five years on £100 deposited (the original £100 plus £25
963The AER is 4.56% and we can see how this works as follows:
965 • £4.56 (4.56% of £100) would be the interest at the end of year 1,
966 • £4.77 (4.56% of £104.56) at the end of year 2,