What is AER?
Anya GairWhen looking to grow savings, understanding the interest rates on accounts is crucial. One term you'll often come across is the Annual Equivalent Rate (AER). Understanding what AER is and how it impacts savings is essential for making informed financial decisions.
Key Takeaways
- AER (Annual Equivalent Rate) allows you to compare savings accounts that pay interest at different intervals.
- Unlike gross interest, AER accounts for the effect of compounding interest over a full year.
- Fixed vs. variable: Fixed AER offers guaranteed returns for a set period, while Variable AER can change based on market conditions.
- Higher is better: Generally, a higher AER means more interest earned, but always check for hidden fees or withdrawal restrictions.
What is AER?
The Annual Equivalent Rate (AER) is a standardised way of showing how much interest you'll earn on your savings over a year. It takes into account whether the interest is paid monthly or yearly and how it is compounded. This makes it easier to compare different savings accounts, even if they pay interest at different times.
For example, if an account has an AER of 1%, this means that if money is left in the account for a year, 1% interest will be earned, regardless of how often the interest is paid and compounded. If your interest is paid monthly, account holders receive 1/12th of the annual rate each month. The interest can then compound (earn interest on itself) throughout the year.
How does AER work?
AER works by standardising the interest earned on savings over a year. It accounts for the frequency of interest payments (monthly, quarterly, annually) and the compounding effect of those payments. This allows for a more straightforward comparison between different savings accounts.
How is AER calculated?
To calculate AER, the following steps should be followed:
- Divide the interest rate on the account by the number of times a year that interest is paid (compounded) and add 1.
- Multiply the result to the number of times a year that interest is paid (compounded).
- Subtract 1 from the subsequent result. AER is then displayed as a percentage (%)
Explore our competitive savings accounts
Join thousands of people who are already working towards their savings goals.
When considering opening a LISA, remember that withdrawals for any purpose other than buying a first home or for retirement will incur a 25% government penalty, meaning you may get back less than you paid in.
What is a variable AER?
AER variable means that the interest rate on a savings account can change over time. Banks may adjust the rate based on market conditions or other factors. When 'variable' is associated with AER, it indicates that the rate is not fixed and could go up or down.
Read more: Are interest rates going up?
What is a fixed AER?
AER fixed means that the interest rate on a savings account is locked in for a specific period, normally between 1-5 years, you will know exactly how much interest will be earned, regardless of changes in the market. This can be advantageous if you want predictable returns on your savings.
What is a good AER rate?
Generally, a higher AER signifies better potential earnings. Current market benchmarks include:
- Competitive: 2-3% AER
- High Yield/Promotional: 4% AER or higher
Always consider account fees, minimum balance requirements, and rate stability alongside the AER.
Conclusion
Understanding AER can significantly impact how individuals choose to save money. By knowing how much interest will be earned and how it is calculated, savers can make more informed decisions and ultimately grow your savings more effectively.
Want to make the most of your savings?
If you’re saving for your first home, retirement, or another life goal, you want to make sure you have the right savings account for your needs. Explore your options with Tembo today.
Coming soon:
Tembo Cash ISA
We know that your savings goals don’t vanish once you’ve bought your first home, or you might want to deposit more than £4,000 each year. So we’re launching a Cash ISA; so you can save up to £20k each year, tax-free.
FSCS-protected up to £120,000
Tax-free deposits up to £20,000
By signing up to receive updates about our Cash ISA, you will be agreeing to our email marketing consent. This gives us permission to send you marketing communications via email with updates on our Cash ISA, which you can unsubscribe to at any time. Read our Privacy Policy here.
