When you want to start saving money, finding the right account can feel confusing. There are many words used by banks that you might not know. One term you will see a lot is AER.
Knowing the Annual Equivalent Rate of an account could help you compare savings interest. This guide will help you understand AER in simple terms so you can choose the best account for your money.
This guide covers:
- What AER means
- How AER works
- The difference between AER and standard interest rates
- The benefits and limitations of AER
- Common questions
What is AER?
The term AER stands for Annual Equivalent Rate. It’s one of the main types of interest rates used on savings accounts.
An AER shows the interest your savings might earn over a year, as a percentage of your balance.
It differs across savings accounts. Some accounts add interest once a month, while others pay it once a year. So, you could look at the AER of each account to compare them at a glance, and get an idea of the potential interest.
As you may expect, a higher AER interest rate could lead to better returns on your savings.
How does AER work?
The AER on a savings account could give you a realistic picture of what your money might earn.
That’s because banks include something called compound interest when they calculate AER interest rates.
This is interest you earn on your savings, plus any previous interest you’ve received on them. In other words, it’s paid on top of what you have already made. It is interest on top of interest.
When banks figure out the AER, they assume two things:
- You leave your money in the account for a whole year.
- The interest rate does not change.
All banks in the UK must use the same rules to calculate AER. They must show this rate in their adverts, which makes it easier for you to compare accounts.
The difference between AER and standard interest rates
Like AER, gross interest is a type of interest rate on savings accounts. It’s a headline rate that shows the interest you might earn before tax deductions.
The main difference between the two is that the AER includes compound interest. But this isn’t the case with the gross interest rate. Because of this, an account’s AER can be higher than its gross rate if it pays interest more than once a year.
The table below shows two different accounts with the same basic gross interest rate. It shows how paying interest more often can change the AER.
| Account type | Gross interest rate | How often interest is paid | AER |
| Account A | 5% | Once a year | 5.00% |
| Account B | 5% | Once a month | 5.12% |
What the table means
Both accounts have the same basic rate of 5%.
Account A pays your interest in one lump sum at the very end of the year. You do not earn any interest on top of interest during the year. So, the AER stays at 5.00%.
Account B pays interest every month. Each month, your balance grows a little bit. The next month, you earn interest on that new, slightly bigger amount. This makes your money grow faster. By the end of the year, your total return is 5.12%.
Knowing this might help when you are looking for new ways to save money.
The benefits of AER
AER can be a helpful tool when browsing for a new account.
The main benefits are:
- Easy side-by-side comparisons of monthly and yearly accounts to see which pays more interest.
- Seeing how much your savings might grow over a year may help you plan a budget.
- Banks cannot use confusing payment schedules to hide a poor interest rate.
The limitations of AER
AER is helpful but doesn’t tell you everything. You might want to consider the following limits:
- Many accounts have variable rates. This means the bank might lower or raise the interest rate due to the economy. If the rate changes, the AER changes too.
- The AER is an estimate based on today’s rate. It assumes nothing changes for a year, which might not happen.
- The AER assumes you don’t touch your money. If you withdraw cash or add more in, the final amount of interest you get will be different.
Account conditions
Banks often have strict rules when you save money. You might need to check the small print to see how to get the advertised AER.
These rules might include:
- Introductory rates that drop to a very low rate after a set period.
- Withdrawal penalties or reduced interest if you withdraw your money before an agreed date.
- You might need a minimum balance in the account, or you will not get the high rate.
- The bank might only pay the high interest rate up to a certain amount. Any money above the maximum deposit limit might earn very little.
Checking the bank’s interest rules before you sign up may help avoid these traps. For some savers, getting quick access to cash might be more important than finding the highest AER.
FAQs
What does AER stand for?
It stands for Annual Equivalent Rate. It shows what you might earn on your savings over one year, including compound interest.
Why is AER useful?
It lets you compare different savings accounts, even if they pay interest at different times.
Is AER the same as an interest rate?
Not quite. The basic interest rate is just the starting rate. AER includes the extra money you make when your interest turns into more interest.
Is AER the only thing to look at when comparing accounts?
You might also want to check whether you can withdraw your money when you need it, and if the rate is fixed or variable.
Can AER change over time?
Yes. If the bank changes its basic interest rate, the AER will change too.
What types of accounts have AER?
Most standard UK savings accounts and cash ISAs use AER.
Does AER apply to shares and dividends?
No. AER is only for savings accounts. If you own company shares, you might have to pay dividend tax on the money you make instead.
Which is better to look at, AER or basic interest rate?
AER is usually better as it offers a more accurate picture of what you might actually earn over a year.
Key points to remember:
AER is a simple percentage that helps compare savings accounts. It shows what you might earn over a full year, including the benefits of earning compound interest.
However, you still need to read the rules for each account. The top rate might depend on you not withdrawing funds or keeping a balance. AER is important, but how easily you can access your money matters too.
If you want to know more about growing your money for the future, you might want to consider the savings options available at Shepherds Friendly.
Please note: No advice has been given by Shepherds Friendly, and if you are in any doubt as to whether an investment plan is suited to your needs, then you should contact a financial adviser. There may be a charge for financial advice, and the cost should be confirmed to you before any advice is given.
