When the interest rate on that debt is expressed as if it were compounded annually, the rate would be referred to as the Effective Annual Rate.
What is the Effective Annual Rate?
- The effective annual rate, effective annual rate, annualized interest rate, or simply effective interest rate is the rate of interest on a loan or financial instrument where interest is compounded in years in which no payments are made.
- The Effective Annual Interest Rate (EAR) is an interest rate adjusted to be compounded over a period of time.
- Simply put, APR is the interest rate an investor can earn (or pay) in his one-year period after compounding.
- The primary difference between the APR and the EAR is that the APR is based on simple interest while the EAR is based on compound interest.
- APR is most useful for valuing mortgages and auto loans, while EAR (or APY) is most effective for valuing frequently favorable loans like credit cards.
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