When you are shopping around for banking products, it's easy to be swayed by the attractively low interest rate because the advertising is designed so that it is the first figure that you see.
However if this figure is the only one advertised, this is misleading because it does not take into consideration the additional fees, account charges and any mandatory insurance that have been added on. EAR, APR and AER were introduced by the British Bankers Association and the Building Societies Association to stop banks and other lenders from getting an edge on the competition by advertising unrealistic rates, and to simplify the process of choosing an account or loan for the consumer.
You should always use the APR as the basis for comparison when looking to borrow money on credit cards or via a mortgage or personal loan, and use the EAR and the AER when looking at bank accounts, because this will make a genuine, like-for-like comparison much easier. This article explains what they mean, and why using them will mean that you make more informed choices and save yourself money.
Although most people do not use them for this reason, current accounts can earn you interest if your account is in credit. The main interest rate that the bank will therefore advertise is the illustration of what your money can earn you if your account is always in the black. However, this does not take into account the interest rates that you have to pay when you go overdrawn, or the charges that the bank applies when you go over your overdraft limit. EAR stands for Equivalent Annual Rate, and should be used to compare bank accounts where there is the chance that you owe money to the bank, calculating the 'true' interest rate when all these potential charges have been considered.
When you are applying for a mortgage or another type of loan, there should always be two figures advertised, the interest rate and the APR. APR stands for Annual Percentage Rate, and takes into account the loan arrangement fee, any loan protection insurance that the loan provider makes compulsory and any additional charges. It could be that a mortgage with a lower-than-average interest rate works out the most expensive when the £1000 arrangement fee is taken into consideration.
AER stands for Annual Equivalent Rate and is usually applied to savings accounts and other interest-based investment products. It shows you the true rate of interest that you will have earned by the end of the year, taking into account how often interest is actually added to the account. Therefore, it will provide all rates as if the interest was compounded (i.e. where you will earn interest on your interest as well as on your capital) and paid annually, rather than monthly or quarterly.
If the AER is lower than the gross rate (also usually advertised), then this suggests that the account pays an introductory bonus rate which lasts up to a year. If the AER is the same as the gross rate, then this suggests that the account pays interest once a year (so no compounding of monthly, quarterly or half-yearly interest takes place). If the AER is higher than the gross rate, then this suggests that the account pays interest more often than once a year. Using the AER as well as the gross rate means that you are not misled by short-term special offers meant to attract new consumers.