Interest on loans and savings
Financial institutions such as banks, credit unions and building societies use different terms for the interest you are charged or earn on their financial products.
The four most common terms you will see are:
- Annual Percentage Rate (APR)
- Equivalent Annual Rate (EAR)
- Annual Equivalent Rate (AER)
- Compound Annual Return (CAR)
APR and EAR are used for the interest you are charged on money you borrow.
AER, CAR and EAR can be used for the interest you earn on money you save.
Interest on borrowings and overdrafts
APR and EAR
The Annual Percentage Rate (APR) is a calculation of the overall cost of your loan. It is expressed as an annual rate that represents the actual yearly cost of the funds borrowed. It takes into account all the costs during the term of the loan including any set up charges and the interest rate. This means that fees and charges are added to the loan amount before interest is calculated.
APR is calculated each year on the declining principal of a loan. The declining principal is the amount you still owe, not the original amount you borrowed. The higher the APR the more it will cost you to borrow money.
All lenders are required to quote the interest rate on a loan or credit card as an APR. These requirements are set down in Section 21 of the Consumer Credit Act 1995.
You can use the APR to compare loans as long as they are for the same amount and the same term. For example, a loan with an APR of 15% is more expensive than one with an APR of 11%. You cannot use APR to compare loans of different terms – if the terms are different you should look at the cost of credit. The cost of credit is the real cost of borrowing. It is the difference between the amount you borrow and the total you repay.
You can use the ccpc.ie loan calculator to work out the monthly repayments and cost of credit for loans depending on:
- How much you want to borrow or
- How much you can afford to pay back each month
The Equivalent Annual Rate (EAR) is used to calculate interest on accounts that can either be in credit or overdrawn. (If you have money in your account, your account is in credit). EAR shows you the rate of interest charged or earned. For example, a current account with an overdraft facility can have 2 EAR rates – one for interest paid when the account is in credit and another for interest charged when the account is overdrawn. If only one EAR is quoted you should find out whether it applies to your credit balance or your overdraft. Always check the interest rate charged on your overdraft facility with your bank.
EAR takes into account when the interest is charged or earned, and any additional charges. Additional charges could include quarterly fees, set-up charges, and so on.
EAR calculates the interest as if it is paid once a year, even if it is paid twice or three times per year. This allows you to use EAR rates to compare an account where the interest is paid or charged monthly with one where the interest is paid or charged annually.
The higher the EAR, the more interest you will be charged or earn.
Interest on savings
AER and CAR
Annual Equivalent Rate (AER) and Compound Annual Return (CAR) both show you the real interest you will have gained on savings or interest-based investments at the end of a year.
AER is the amount of interest earned in a year. AER is useful for comparing the return on savings accounts because it shows how much is earned regardless of how often interest is credited to an account. It is standard practice in Ireland to list interest in AER form for savings accounts. You may earn less than the AER because your money may not be invested for as long as a year. AER is usually quoted without taking DIRT into account.
Sometimes firms use Compound Annual Rate (CAR) instead of AER on savings and investment products. CAR is a measure of the rate of return on a deposit or investment. You can use it to compare different accounts. If there is €110 in an account, a year after €100 was lodged in it the return, or CAR, is 10%.
AER and CAR both take into account how often interest is paid because when the interest is added to your savings your savings increase. As a result, the next time the interest on your savings is calculated this increases too. This called compound interest.
An example of compound interest:
If a financial institution quotes an interest rate of 4% per year compounded every 6 months the financial institution pays 2% compound interest every 6 months. The interest paid at the end of 6 months, actually earns interest for the second 6 months of the year. For this reason, 4% compounded every 6 months, is not the same as 4% compounded annually.
You invest €500 with your financial institution at a rate of 4% each year, compounded every 6 months. The €10 interest for the first 6 months is simply 2% of €500. This is then added to the initial investment to give a running total of €510. The interest for the second six months of the year is 2% of €510 = €10.20. The effective annual interest rate is therefore 20.20 /500 x 100 = 4.04%.
If a financial institution, quotes an AER or CAR rate for an account, there may also be terms and conditions attached to that account which can stop you from getting the full rate. For example, you may not get the full rate if you withdraw your savings before a certain date.
AER and CAR do not take into account fees or charges.
Where to apply
If you have a complaint about a financial institution, contact the Office of the Financial Services and Pensions Ombudsman. If you feel that an advertisement in Ireland was misleading, you can make a complaint to the Advertising Standards Authority for Ireland.