AER vs. Gross?

Rik – Perhaps Martin Lewis can write an article answering this commonly asked question. Or maybe he can invite an article to be written by one of the bank or BS workers who contribute comments to this forum. It could be linked on the left, in the Banking + Savings & Investments sections.

By some interpretations it can seem misleading that some financial institutions boast an AER rate, fooling many potential customers into assuming "5% AER" offered, say, by ING Direct is equal to "5% gross" offered by Nationwide for their e-Savings a/c. In fact ING's true equivalent is 4.89% gross. (All banks & BSs quote this in a minor way in a/c info.) Personally, I always compare only gross rates.

5% AER on an a/c paying interest monthly (eg ING Direct), instead of the more usual annually, is actually more like 4.8% divided by 12, per month. It's made up to 5% by earning interest on the interest (known as 'compound interest') – ie if £1,000 is invested, after 1 month it's earned approx £4, so £1,004 is invested from that time until the next month is up (assuming no withdrawals).

5.40% gross is currently offered by Birmingham Midshires (a division of Halifax plc) for their Internet Easy Access Savings a/c. This includes a bonus for the first 12 months. (At or before the anniversary, customers may decide to move some or all their £'s elsewhere, when that bonus expires.) One linked external a/c is allowed, so the customer can easily make partial withdrawals. (My family is waiting to learn from this site's contributors how many days it takes, in their experience, to move £'s in this way – I loathe earning nil interest while £'s are in-transit!)

5.10% gross is offered (nil bonus tricks) by Norwich & Peterborough BS for their online savings a/c. Instant transfers from that can be done online to the Society's cheque a/c, and BACS transfers from there to any number of a/c's with other financial institutions.

I'm assuming you've already invested some of your money in a Mini Cash ISA (eg. up to £3,000 allowed in this tax year). Also, are you investing some of your money in regular, monthly savings a/c's, as advocated by Martin Lewis? Maybe you already know about Abbey's new Fixed Rate Monthly Saver (offering 6.50% gross), Halifax's Regular Saver (6% gross) and Derbyshire BS's Regular Savings a/c @ 5.85%. For instant access, up to £2,500 could earn 5.37% gross (advertised as 5.50% AER) via Alliance & Leicester's Premier Plus Current a/c, if you can move £1,000 in (& out, if you want!) each month.

I thought AER = gross if interest is paid annually!?

thekc wrote: »

Could someone give me an example to illistrate why they are different

AER illustrates what the interest rate would be if it was compounded once per year. Since there's no annual compounding with the 3 year term (interest is paid on maturity), interest is accrued daily at a higher rate. For example, assuming a £1,000 deposit...

£1,000 x 1.0715 x 1.0715 x 1.0715 = £1,230.20 (where 1.0715 is the AER multiplier)

£1,000 x 7.67% = 76.70 interest per year, and because there's no annual compounding, a 3 year term would therefore give 3 x £76.70 = £230.10 total interest.

Add this to your £1,000 deposit and you have £1,230.10