The effective interest rate (EIR), effective annual interest rate, Annual Equivalent Rate (AER) or simply effective rate is the interest rate on a loan or financial product restated from the nominal interest rate as an interest rate with annual compound interest. It is used to make loans with different compounding terms (daily, monthly, annually, or other) more comparable.
Formula to calculate EIR for Daily, Weekly or Monthly compound is as below,
While for Flat Rate/Fixed Rate, the formula is as below,
Quite complicated huh?…don’t panic. I’ve created EIR calculator using Excel and you can download it from here => Effective Interest Rate Calculator.
Why we need to know about EIR?…as you know, there are several type of interest…daily rest, monthly rest, flat rate…so EIR to be used to comparing these interest type with a standard rate/calculation.
Lets calculate EIR for different interest type.
* Home Loan [ monthly rest, 6% per annum] => EIR = 6.17%
* Overdraf [ daily rest, 6% per annum] => EIR = 6.18%
* Personal Loan [ flat rate, 6% per annum ] => EIR = ~11.4%
Could you see the different? Even though all of loan above offering the same interest rate per annum, which is 6%, but EIR for personal loan is more higher that what is announed by bank. So they actually charges you more in term of EIR.