What's the difference between AER & APR?

Whether you’re a saver or a borrower, it’s important to understand how interest works. This is because it affects what you earn from your savings or how much you’ll pay when you borrow money. 

In this article, we'll explain the common interest rate jargon that you may come across when searching for loans, mortgages, credit cards or savings accounts.

What is AER?

AER stands for ‘Annual Equivalent Rate’. It’s the format most commonly used to show interest rates for savings accounts in the UK. AER is the annual interest rate earned on your savings, adjusted for compound interest (see more on this below), and any savings bonuses or fees.

You  may also come across the interest term ‘Gross Interest’. Like AER, this shows the annual interest rate you will earn on your savings, but unlike AER, it doesn’t take into account anything else like compound interest or bonuses/costs associated with the account.

Savings account providers are required by the Financial Conduct Authority (‘FCA’) to show the AER for each account they offer. This allows you to compare different accounts directly, making it easier to choose the right one for you.

What is compound interest?

We’ve mentioned that AER includes compound interest, but what does this mean? In simple terms, compound interest is when you earn interest on the interest you’ve previously earned. 

Interest on savings can be paid daily, weekly, monthly or annually, giving you a larger balance than when you started. When your interest is calculated for the next period, it will be calculated on this larger balance made up of both your initial deposit and the interest earnt. This process continues with each interest earning and payment period, helping your savings grow faster. 

Here’s an example; 

Imagine a savings account with a £2,000 balance and an annual interest rate of 5% AER.

In year one, you’d earn £100 in interest, giving you a new balance of £2,100. 

In year two, you’d earn interest on the new balance, which would be £105 in interest, giving you a new balance of £2,205. 

This compounding would continue each following year, which means if you kept the account open for ten years without withdrawing or adding any money, you’d have £3257.79 in the savings account. 

Compound interest works for you when it comes to savings, but may work against you when it comes to borrowing money. If you fail to pay off monthly interest charges on your debts, you may be charged interest on the missed interest payment, which can make your debt increase more quickly. If you are ever in a position where you think you may struggle to pay back money you owe, contact your lender to discuss your options.

What is APR?

Whilst AER is the most common type of savings interest rate, APR is the most common for borrowing. APR stands for ‘Annual Percentage Rate’. It shows the cost of borrowing over a year, including both the annual interest rate, any introductory offers or any extra fees associated with the product.

APR is used to compare the cost of borrowing products like loans, mortgages and credit cards. Unlike AER for savings, APR for borrowing does not include compound interest. 

When looking for credit products, you may come across the phrase ‘representative APR’, which is a regulatory requirement for all lenders to display. The representative APR shows the interest that a typical customer will pay for that product – 51% of current customers must be paying the representative APR more. Like APR, the representative APR includes interest, introductory offers, and any other charges.

It’s important to remember that the representative APR is only a guide, and the APR offered may be higher or lower than this. Your personalised APR will be based on how much you want to borrow, your financial situation and your credit history. 

What is APRC?

APRC stands for ‘Annual Percentage Rate of Charge’. It is sometimes used for mortgages and secured loans and shows their yearly cost across the whole repayment period. A secured loan is a personal loan that is secured against an asset like a house, meaning the lender may have a right to some or all of that asset if payments are missed.

The APRC calculates the total cost of borrowing, including the interest you’ll pay and all charges associated with the loan, such as the cost of arranging it, valuation fees and legal fees. 

APRC is a great way of understanding the potential cost of a mortgage or secured loan to help you make an informed decision about borrowing. This is important to consider because these loans typically have longer repayment terms, which may impact your finances for a long time. 

However, APRC does have some limitations, particularly for mortgages. It assumes you don’t remortgage or change provider for the whole term, which most mortgage holders do. There are also some mortgage costs it may not include. Finally, it cannot account for future interest rate changes which will likely have a huge impact on the total amount paid back.

Fixed and variable interest rates

When it comes to savings and borrowing products, there are two types of interest rates: variable and fixed. With fixed rates, the interest remains the same for a set period of time. 

With variable rates, the interest can change based on the Bank of England Base Rate. This means you're not guaranteed the same amount of interest on your savings, and the cost of borrowing can fluctuate.

Some people prefer fixed interest rates when borrowing because it helps them budget their monthly repayments. However, if you take out a fixed-rate loan when interest rates are high, you won't benefit if interest rates fall. On the other hand, you won’t be impacted by any rate increases.

It's important to consider how interest rate changes can impact the cost of your loan and your monthly finances before borrowing money.

Fixed savings accounts restrict access to your money for a certain amount of time, known as the fixed-rate period. You usually cannot withdraw money during this time without additional chargers or giving up some of the interest you’ve earnt. In contrast, variable savings accounts usually offer more flexibility, allowing you to withdraw money with less restrictions.

In summary, fixed savings accounts offer higher interest rates but limited access to your savings, while variable savings accounts usually provide flexibility but may have lower interest rates, which can change. Which one is best for you, will depend on your personal financial goals. Many people choose to have both types of accounts, so they can benefit from higher rates for locking their savings away, whilst still having easy access to money in case of an emergency.