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 Rate (CAR)

APR and EAR are used for the interest you are charged on loans and overdrafts.

AER, CAR and EAR can be used for the interest you earn on savings.

The Annual Percentage Rate (APR) is a calculation of the overall cost of your loan. It is 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 reducing amount of the loan you still owe as you pay it back. The higher the APR the more it will cost you to borrow.

All lenders must quote the interest rate on a loan or credit card as an APR. This requirement is in Section 21 of the Consumer Credit Act 1995.

You can use the APR to compare loans once 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.

The CCPC has a loan comparison tool that shows you the total cost and monthly repayments for personal loans that are available.

The Equivalent Annual Rate (EAR) can be used to calculate interest earned on an account that has money in it or interest charged on an account that is overdrawn. 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. Examples of additional charges are quarterly fees or set-up charges.

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.

Annual Equivalent Rate (AER) and Compound Annual Rate (CAR) both show you the real interest you will earn 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 as AER for savings accounts. You may earn less than the AER because your money may not be invested for a full 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, for example, tracker bonds.

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 – see example below.

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.

The CCPC has savings comparison tools that show you the rate and amount of interest paid by savings and deposit accounts that are available.

Example of compound interest:

If a financial institution quotes an interest rate of 4% per year compounded every 6 months, it pays 2% compound interest every 6 months. The amount of interest that is paid at the end of 6 months then 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.

For example, you invest €500 with your bank at a rate of 4% each year, compounded every 6 months. For the first 6 months, the interest of 2% on €500 gives €10. This interest is then added to the initial amount to give a running total of €510. The interest for the second 6 months of the year is 2% of €510 = €10.20. Added to the €10 for the first 6 months, this gives €20.20 for the year. The annual interest rate is therefore 20.20/500 x 100 = 4.04%.