Effective annual rate (EAR)
Principles of Finance glossary · Time Value of Money
Definition
The actually realized annual rate accounting for intra-year compounding.
Effective annual rate (EAR) in plain English
The effective annual rate is the interest rate you TRULY earn (or pay) over a year once you account for 'compounding' — the fact that interest can itself start earning interest when it's added to your balance more than once a year. A bank might advertise '12% a year,' but if it actually pays 1% every month, each month's interest joins your balance and earns more, so you end up with a bit more than 12% — that's the EAR. In short, the sticker rate can understate reality; the EAR is the honest number that lets you compare a monthly-compounding deal against a yearly one on equal footing. The more often interest is added within the year, the more the EAR climbs above the advertised rate.
Also called: EAR
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