EAR Calculator – Find the Effective Annual Rate
Calculate the effective annual rate (EAR) by entering the annual rate and compounding frequency in the calculator below.
Effective Annual Rate:
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Joseph Rich holds a Master's degree in finance and a Bachelor's degree in economics. He specializes in economics and investing analysis.
Laura started her career in Finance a decade ago and provides strategic financial management consulting. She has an MBA in Finance and a Bachelor's in Economics.
How to Calculate the Effective Annual Rate
The effective annual rate (or EAR) converts a simple interest rate into a compounding interest rate. A compounding interest rate earns interest on a prior period’s interest payments and the principal value. A simple interest rate is one in which interest is earned only on the original principal value.
Since the EAR is a compounding interest rate, the more times interest is compounded in a year, the higher the interest rate will be. This is the “n” term in the effective annual rate formula below.
If you are a lender, you would want interest to be compounded continuously since that will generate the highest interest owed to you. However, if you are a borrower, you would want to pay the least amount in interest, which comes from an interest rate that is compounded annually.
The different compounding periods in the effective annual rate calculator are continuous, daily, weekly, semimonthly, monthly, quarterly, semiannually, and annually. These are in order of the highest EAR to the lowest.
You can also use our APY calculator to calculate the annual percentage yield, which is essentially the same rate as the EAR.
EAR Formula
The effective annual rate formula is as follows:
Where:
EAR = effective annual rate
r = annual rate
n = compounding periods
Example
Let’s use an example to show the difference in the EAR with the same interest rate, but different compounding periods. We will assume an annual rate of 7% and see what the difference is between semimonthly (n = 24) and semiannually (n = 2) compounding.
Semimonthly
Semiannually
You can find the same rates using the effective annual rate calculator above. This shows that compounding the interest rate 24 times per year results in a higher effective annual interest rate than compounding only twice a year.
The EAR range is from 7.0% under annual compounding to 7.2508% under continuous compounding.
You can use our APR calculator to calculate the true cost of borrowing on a loan that includes financed and prepaid fees.
Overall, an effective annual rate is important to understand so that you can compare different loan or investment options that may have varying annual interest rates or compounding frequencies.
Frequently Asked Questions
What's the effective annual rate used for?
The effective annual rate can be used in savings accounts, checking accounts, or a certificate of deposit (CD).
Assume you have opened a $10,000 certificate of deposit that pays you 4% compounded quarterly. Instead of receiving 4% interest at the end of the year, the financial institution will pay you 1% each quarter.
The effective annual rate calculator shows that this gives an EAR of 4.0604%. Instead of $400 in interest, you will have $406.04. This extra $6 might seem insignificant, but with larger amounts and a longer period, compounding interest will lead to a much larger amount of interest earned.
This extra interest is free. There is no extra work or risk involved in receiving it.
Although a compounding rate can be found on a loan, it’s rare. When you are making loan payments each month, you are not paying interest on the prior period’s interest payments. You are only paying interest on the current principal value.
What does it mean when there are two rates mentioned on a loan?
Usually, a nominal or annual interest rate as well as an effective annual rate are mentioned on loan and investment offerings. The nominal rate is the face value rate, while the EAR is the rate you will actually receive or pay.
The example mentioned in this article shows that the nominal interest rate is 7% but the EAR with compounding semimonthly is 7.2399%
Why do we use EAR instead of just an annual interest rate?
The annual interest rate may not tell you the true cost of interest, depending on how often it compounds. It’s important to understand the EAR so that you don’t underestimate what you are paying or earning in interest.
What impacts the effective annual rate (EAR)?
Various items may affect an EAR you are offered on a loan or investment, including your credit score, inflation, and current Federal Government monetary policies.