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Compound or simple interest?
muymalestado
Posts: 43 Forumite
Sorry if this has been raked over already - I didn't search correctly if so - but; my question is that I notice banks describing their savings accounts without using the words 'compound interest', so are the rates given always assumed to be simple annual tranches of interest, or do they actually compute a compound rate without telling us?
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AFAIK all savings accounts offer compound interest, in that they pay interest on interest, when it is credited to your account. Most interest is calculated daily and paid either monthly or yearly.
All accounts will provide the AER%, annual equivalent rate, which is the simple interest for a year.In case you hadn't already worked it out - the entire global financial system is predicated on the assumption that you're an idiot:cool:0 -
No. The whole point about quoting AER is that it is NOT simple interest. It takes account of compounding ie where interest is paid monthly.All accounts will provide the AER%, annual equivalent rate, which is the simple interest for a year.
So the AER will allow you to compare accounts where interest is paid monthly and compounded, with accounts paid once, annually. At the end of the year you will have earned...... AER. It also takes account of situations where the interest rate changes ie a 6 month bonus rate - AER will show the actual rate over the year, not just the pre or post bonus rates.0 -
Simple interest will be paid into another account usually, some high interest fixed term bonds etc that are out there atm are like this, you get 5% paid out monthly but it isn't allowed to compound.Norn Iron Club member No 3530
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AER accommodates compounding. Interest paid within the year is assumed to be reinvested at the same nominal rate as the existing principal.
I'm unable to post links as yet, but the BBA website contains all of the formulae and attendant explanations. Here's a sample from the BBA site :
If an account pays interest more often than once a year, then the AER is calculated by adding each interest payment to the deposit and calculating the next interest payment on the total – compounding the interest.
The key point being transparency and comparability for the consumer - AER is ostensibly an equivalent simple interest rate.0 -
So is a 5 year fixed rate savings account with an AER of 5.25% creditted interest anually and compounded?0
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The 'A' = annual. So this is an annual rate. If interest is added annually, then this is the simple gross rate for a year. It does NOT take into account interest added last year or the year before and provide the compound rate over the 5 years.AER of 5.25%
AER is the standard rate quoted by all banks for ease of comparison. It would be impossible to have a standard way of showing interest that took account of every account type, 6 month bonus, monthly interest, 2 year bond etc etc.0 -
The Halifax Websaver Fixed account allows you to choose between two options to have your interest paid: 1. you can have it annually paid into another account or 2. paid at the end of term, so you wouldn't see any interest added until the end of the 5 years. I assume if you take the latter option they still re-invest and compound.
I wonder if the Halifax's savings calculator is a reliable way of knowing exactly how much interest I will get at the end of five years. It does not fill me with confidence.
I've just opened one of these accounts with a lot of money and as it's fixed, I want to know exactly how much I stand to gain.0 -
Pitchshifter wrote: »The Halifax Websaver Fixed account allows you to choose between two options to have your interest paid: 1. you can have it annually paid into another account or 2. paid at the end of term, so you wouldn't see any interest added until the end of the 5 years. I assume if you take the latter option they still re-invest and compound.
Correct. If you choose for interest to be paid on maturity, then they compound it annually, on the anniversary of opening the account.Pitchshifer wrote: »I wonder if the Halifax's savings calculator is a reliable way of knowing exactly how much interest I will get at the end of five years. It does not fill me with confidence.
I've just opened one of these accounts with a lot of money and as it's fixed, I want to know exactly how much I stand to gain.
You're getting 5.25%, right?
In that case, multiply the balance in the account by 0.29154791 to get the total amount of interest that'll be paid at the end of the five year term.0
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