Understanding interest rate terminology

Each savings account across different banks will tend to have different interest rates.

At the time of writing, a typical offer with a high street bank for a bog standard interest account might be something like 1 - 2% whilst with smaller online only savings accounts elsewhere you might be looking in the region of 5-6%.

Sometimes you might get higher rates, but these are usually with strings attached (see the relevant article on conditions for more information on the stipulations sometimes applied with savings accounts).

Now, we all tend to know that if we are offered 6% interest then that is better than being offered 0.1% interest on our current account for instance, though of course a lot of us aren't that good at managing our money and lose hundreds or even thousands during a lifetime as a result of sub-optimal money management.

So, what does the interest rate actually mean though - if I have £10,000 in a savings account at the start of the year and I leave it untouched, how much interest do I get at the end of the year?

Well, the further complexity comes with two different figures that are told to us, the AER and the Gross per annum figure.

AER stands for 'annual equivalent rate' and this tends to get listed on the promotions as it works out higher than the gross amount.

So typically you might see a savings account advertised with something like this:

4.26% AER (4.18% gross pa)

Let's work out what that means, since they both refer to the amount you get in the same account.

Well, the gross is the rate of interest that is payable before income tax is deducted. What does this mean? It means if you don't pay tax, then you actually get interest at that rate on the account.

The AER tells you what the interest rate on the particular savings account would be if the interest was paid and then compounded each year, and hence it is a higher figure.

And so there you have it - the difference between AER and gross and what each of those percentage figures means!

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