In this week's millennial money episode, I ask financial expert Damien Fahy about interest rates and what they mean.
In the world of money and finance, you often hear the term interest rates, and in particular the terms APR and AER. What do they mean and what is the difference between them?
What does APR mean?
When you take out a loan you will often see something called the Annual Percentage Rate (also referred to as APR). APR is often used when you apply for things like loans, credit cards and mortgages. Credit cards and loans will often have different interest rates and charges and when you combine that with the fact that the repayment terms will often be different, it can be very difficult to compare apples with apples in terms of the overall amount you will pay back.
The annual percentage rate however is the rate that you pay, taking into account not only the interest rate but all of the charges spread over the year. Knowing the APR (or the 'equivalent APR' as it is often referred to in advertising) will allow you to compare the total costs of borrowing.
Be aware however that not everyone will be offered the advertised APR rate. For a company to be able to advertise the 'equivalent APR rate, at least 51% of customers must be on it. The total APR that you will be offered will ultimately boil down to how much of a risk you are to the lender.
The higher risk you are the higher the interest rate you pay
What does AER mean?
The Annual Equivalent Rate (also referred to as AER) is similar to APR but it applies to savings rates instead of loans. As with the APR, AER combines the interest rate as well as any bonuses you may receive for your savings account and then combines them under the AER.
When it comes to comparing two savings accounts, the best account is the one with the highest AER. It is worth remembering though that the AER and the amount of interest you actually receive monthly may be less than the gross rate advertised as the AER uses averages and includes the initial 'teaser rates'.
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