1. What Is The Annual Equivalent Rate (AER)?

The Annual Equivalent Rate (AER) is a standardized way of expressing the annual interest rate on mortgages and other financial products that accounts for compounding. It shows the true annual cost of borrowing by incorporating how often interest is applied to the principal.

2. How Does The Calculator Work?

The calculator uses the AER formula:

Where:

• \( R \) — Annual nominal interest rate (as a decimal)
• \( n \) — Number of compounding periods per year
• \( AER \) — Annual Equivalent Rate (as a decimal)

Explanation: The formula calculates the effective annual interest rate when compounding occurs multiple times per year, providing a more accurate representation of the true cost of borrowing.

3. Importance Of AER Calculation For Mortgages

Details: Understanding AER is crucial for mortgage comparisons as it reveals the true annual cost of different mortgage products, especially when they have different compounding frequencies. A higher AER indicates a more expensive mortgage.

4. Using The Calculator

Tips: Enter the annual nominal interest rate as a percentage and the number of times interest is compounded per year. The calculator will show the effective annual rate that accounts for compounding effects.

5. Frequently Asked Questions (FAQ)

Q1: Why is AER different from the nominal interest rate?
A: AER accounts for compounding effects, while the nominal rate does not. The more frequently interest compounds, the higher the AER will be compared to the nominal rate.

Q2: How does compounding frequency affect AER?
A: More frequent compounding (monthly vs annually) results in a higher AER because interest is calculated on previously earned interest more often.

Q3: Is AER the same as APR?
A: While similar, AER typically refers to savings and investment returns, while APR (Annual Percentage Rate) includes fees and other costs associated with borrowing.

Q4: Why is AER important for mortgage comparisons?
A: AER allows borrowers to compare mortgages with different compounding frequencies on an equal basis, showing the true annual cost of each option.

Q5: Can AER be lower than the nominal rate?
A: No, AER is always equal to or higher than the nominal rate due to compounding effects. With annual compounding, they are equal; with more frequent compounding, AER is higher.