While APR is a more accurate estimation of the total cost of a loan than the nominal interest rate, it is limited because it only considers a simple interest rate. If the interest compounds on a smaller time frame than annually (such as monthly or semi-annually), the actual interest paid will be higher than the APR advertised. Factoring in compounding interest that happens within a year gives you a loan's EAR, or Effective Annual Rate (sometimes also called APY, or Annual Percentage Yield). As a helpful rule of thumb, most credit card companies use an APR compounded monthly, whereas most mortgages use an APR that is calculated on an annual basis and is therefore the same as EAR. If you are carrying credit card debt, your APR is already high to begin with, but your EAR is even greater than the stated APR, plus you may be charged additional fees for late payments! Here is how to remember interest rate, APR, and EAR: Compounding interest monthly rather than annually and other maneuvers like these to further enslave those in credit card debt is why credit card companies and other consumer lenders have a poor reputation. Now that you know the difference between the nominal interest rate, annual percentage rate, and effective annual rate, consider sharing this information with a friend to help them with their financial situation.APR and EAR
How Credit Card Companies May Take Advantage
APR vs EAR FAQs
Annual percentage rate is a rate charged per year on an amount of money that is borrowed as a loan or invested, which factors in associated fees in addition to the interest rate.
Effective annual rate is the interest rate on a loan which factors in any associated fees as well as compounding interest that happens on a smaller time frame than one year.
APR factors in any associated fees, but does not account for interest compounding on a smaller time frame than one year, whereas EAR accounts for both associated fees and interest compounding on a smaller time frame than annually.
Another name of EAR is APY.
Most credit card companies use an APR compounded monthly, whereas most mortgages use an APR that is calculated on an annual basis and is therefore the same as EAR.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.
