What does AER mean? How to compare savings rates

AER is the Annual Equivalent Rate of each savings account, calculating exactly how much interest you could earn by drawing on both the gross interest rate and any potential compounding effect. As a result, AER can be helpful when comparing savings rates because it offers a calculation of how much your savings could grow in each individual account.

What is the Bank of England base rate?

The Bank of England sets a base rate each month, which guides the wider market interest rates and is subject to regular change. Because it’s a national baseline rate set for the entire country, it ultimately influences the rates banking providers pay to borrow, or earn to store, money. The Bank of England will adjust its base rate as a way to guide inflation, raising it to slow spending down or lowering it to encourage financial growth.

How is savings interest calculated?

The majority of savings accounts calculate savings interest based on the closing balance in an account at the end of the day, adding these amounts up and then paying them into the account either monthly or annually depending on the interest structure.

For example, if you deposit £1,000 into an account with a 3% interest rate with an annual interest payment, then you’ll earn £30 in interest that year, paid in a single sum after 365 days. This breaks down to £0.082 earned via interest per day.

How do payment frequency and compounding matter?

More frequent interest payments lead to a greater compounding effect, essentially allowing you to snowball the growth of your funds by earning interest on both your money and interest you’ve already earned.

To give an example, if you deposit £1,000 into an account with a 3% interest rate that pays interest monthly, then you’ll end up with £1030.42. This is because each small monthly interest payment is earning interest on both your £1,000 deposit and any interest you’ve already earned. The longer you keep money in these accounts, the more the gap between annual and monthly payments can be felt as the compounding effect snowballs further and further.

What should you compare between accounts?

Using AER, you can more easily compare between accounts because it shows you how much money you’ll earn by combining both the gross interest rate with the compounding effect. This is especially helpful in fixed-rate bonds, where the added factor of a fixed length of time helps you better understand how time magnifies the compounding effect.

What does AER mean? How to compare savings rates

In summary:

• The Bank of England base rate, can change depending on the rate of inflation and influences what interest rates banks across the country offer with their savings products.
• AER is the Annual Equivalent Rate which calculates how much interest you’ll actually earn from an account by drawing on both its gross interest rate and any compounding effect.
• As a result, AER can be a useful tool when comparing savings accounts because it shows the reality of what each product will offer you in financial growth.
• The regularity of interest payments plays a key role in this growth, with more frequent monthly payments ultimately generating a greater compounding effect than annual payments.

Frequently asked questions

What does AER mean on a savings account?

AER stands for Annual Equivalent Rate and shows the true annual interest you’d earn on a savings account by including compound interest.

How is AER calculated?

AER is calculated via a mathematical formula where the nominal interest rate (decimalised) is added to the number of compounding periods per year (how often your interest is paid and your level of compounding interest).

What’s the difference between AER and the interest rate?

AER essentially combines the value of a standard (or ‘gross’) interest rate with the effect of compounding interest, allowing you to see exactly how much you’d earn in a year in a savings account.

Why is AER useful when comparing savings accounts?

AER shows you how much you’d actually earn in each account by calculating yield based on both the gross interest rate and compounding interest earnings. In this way, an AER rate is useful for comparison because it shows the reality of how much money each account will earn you in interest.

How does compound interest affect my savings?

Think of compound interest as earning interest on top of interest. The longer your money stays in your savings account, the more opportunity it has to grow, giving your savings an extra boost over time.

Does it matter how often savings interest is paid?

Yes, as more regular savings interest payments can lead to higher compounding effects. Monthly payments can offer greater compounding than yearly payments, as they grow your money in small, regular increments that allow you to more frequently earn interest on both your money and the interest it’s accumulated.

Can the AER on a savings account change?

Fixed AER rates will stay consistent. However variable AER rates can naturally rise or fall in time based on market conditions as guided by the Bank of England’s base rate.

What should I look at besides AER when comparing savings accounts?

Account types and conditions, such as the level of access each account provides and whether there are any withdrawal restrictions, can also be helpful factors when comparing savings accounts.

Where can I check the latest rules and product terms?

You can review the latest rules and terms here.

Next steps

If you’re looking for further helpful information on what does AER mean and how to compare savings rates, click below:

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