Ear we go again. 30 October 2004 at 12:57PM in Savings & investments 5 replies 987 views

Robert_Sterling_3

The Halifax and The Abbey each have a regular saver account.
Each pays 7% per annum.
However the Halifax pay 7% per annum for less than an annum. [Strange ]
It is not clear to me why this means that they can say AER 7.07% but they do.  The Abbey say that they could say 7% per annum and about 7.2% AER but they don't.
Some best buy tables put Halifax at the top followed by Abbey.  The Halifax says it has to show the AER as 7.07.  The Abbey do not show their AER as 7.2%.  Hmmm.  

Based on G Gilmore in The Times

Unbelievable_2

The Abbey is only for an annum if you make your first deposit on the first of the month. The account ends on the first day of the anniversary month.

MarkyMarkD

Don't they both pay interest annually, in which case 7% basic should equal 7% AER? Where does 7.2% come from???

Robert_Sterling_3

One answer is that the 7.2% comes from an article on the front page of the money section of The Times today.
The accounts don't last a year ( some do most dont because of the terms and conditions )
I assume that you get 7% up to the day they pay you the 7% and thereafter for any thing up to 30 days you get interest on the interest.  How you calculate the AER when an account pays interest in this strange way varies.

It is a bit like 1% per month paid monthly is 12% per annum and 12.68% AER.

MJSW

This reason the AER is more than 7% isn't really much to do with compounding of interest at the end, although it is to with the timing of the interest payment.

The equivilent rate of return will depend not only on the frequency of the interest payments, but on the timing of the interest payment as well. You might assume that all accounts paying 5% interest annually would be equivilent.

If you opened an account with £100 on 1 Jan which pays 10% gross annually on 31 Dec, then in 12 months time you would have £110. Then suppose you opened another account with £100 on 1 Jan, which also paid 10% gross annually, but this time interest was added to the account on 30 June each year instead of 31 Dec. With this account, which pays exactly the same rate as the first, you would have £110.25 if you closed it in 12 months time (6 months at 10%pa=£5, then another 6 months on a balance of £105 at 10%pa = £5.25). So the effective rate over that 12 months is 10.25% instead of 10%. The only difference between the two accounts is that the 2nd has paid the interest earlier than 12 months after the deposit, and that increases the effective rate of return.

A similar effect occurs with with a monthly saver. Interest on the first deposit will be paid after (approx) 12 months, so no adjustment needed. But interest on the 2nd deposit will be paid after only 11 months, the 3rd after 10 months, .... etc and the final deposit receives some interest after just 1 month. So all deposits after the intial one get their interest paid sooner than 12 months, so the equivilent rate of interest on those deposits is higher than the actual flat rate paid on the account.

MarkyMarkD

OK, I sort of get those comments, for which thanks.

But in fact every MSE will close their account as soon as the 7% period expires, so none of the MSE will get their interest compounded. BUT they will get the interest less than one year after the funds were deposited, so I see how that makes the AER more than 7%.