Gross V AER - what does it all mean

JBmoney

OK, this is to the finance savvy.
If 2 rates listed for a term deposit ( 3 yrs ), Gross being 5.81% and AER being 5.5%, which figure is used to work out the compounded on a deposit ? Also, if you could do so simply, can you please explain difference ?

Baldur

See http://www.moneysavingexpert.com/banking/interest-rates#AER

Lokolo

The total amount you will get at the end of the fixed term is 5.81%, which in annual equivalent terms is 5.5% per year.

JBmoney

Would it be accurate to state ( using the rates I`ve referred above ) that you would on a 3 yr term deposit receive 5.81% for year 1 and then compounded at 5.5% for subsequent years ?

YorkshireBoy

JBmoney wrote: »

Would it be accurate to state ( using the rates I`ve referred above ) that you would on a 3 yr term deposit receive 5.81% for year 1 and then compounded at 5.5% for subsequent years ?

No.

Assuming a deposit of £1,000...

You accrue interest daily at the 5.81% gross p.a. rate and the whole 3 years interest is paid at the end of the term, ie (£1,000 + (£1000 x 5.81% x 3)) = £1,174.30 closing balance (of which £174.30 is interest).

The 5.5% AER figure is calculated as the rate applicable if the interest was paid and compounded annually, ie £1,000 x 1.055 x 1.055 x 1.055 = £1,174.24 closing balance (of which £174.24 is interest).