What is the effective annual rate

When you take a loan, the interest rate shown by the lender is usually the nominal or stated rate. This rate looks simple, but it does not show the full picture. It ignores how often interest is added during the year. This is where the effective annual rate, or EAR, becomes important.

If you want to understand your actual borrowing cost better, you can check your pre-approved loan offer with your phone number and OTP, apply online in minutes, and get funds in 24 hours* with no branch visit needed. It takes only 2 steps to check your eligibility and plan with clarity.

The effective annual rate takes compounding into account and shows the real interest you pay in a year. In this article, we explain what EAR means, why it matters, and how to calculate it using a simple formula.

The effective annual rate, also called the effective annual interest rate, is the actual percentage of interest a borrower pays in one year after considering compounding. It depends on the nominal interest rate and how many times interest is compounded in a year.
 

Why it matters: EAR is not affected by the loan amount. Instead, it helps you understand the true cost of borrowing, making it easier to compare loans that use different compounding periods.

Understanding the effective annual interest rate is especially useful when taking a personal loan. Nominal rates give only a surface-level view and may look similar across lenders.

EAR shows the real cost by factoring in compounding. This helps you compare loan options more accurately and avoid surprises later. If you are exploring loan options, you can also check offer in 2 steps and see what suits your needs best.

The effective interest rate (EIR), also known as EAR, reflects the true yearly cost of a loan after including compounding. Unlike the nominal rate, it shows how interest builds up over the year.

To calculate the EIR for a personal loan, use this formula:

EIR = (1 + r/n)n − 1

where:
r = nominal (stated) annual interest rate
n = number of compounding periods per year (for monthly compounding, n = 12)

The effective annual rate formula combines the nominal rate and compounding frequency:

EAR = (1 + i/n)n − 1

where:
i = nominal interest rate
n = number of compounding periods

To avoid manual calculations, you can also use a personal loan EMI calculator to estimate EMIs easily.

As compounding becomes more frequent, the effective annual rate increases slightly because interest is added more often.

Suppose you take a personal loan with a nominal interest rate of 15%, compounded monthly. The EIR would be calculated as:

EIR = (1 + 0.15/12)12 − 1 ≈ 16.08%

This shows that monthly compounding increases the actual interest paid. Knowing this helps borrowers judge the real cost of a loan and make better comparisons.

The annual interest rate, also called the nominal rate, is the basic rate quoted by lenders. It does not include the effect of compounding.

The effective annual interest rate includes compounding and therefore gives a more accurate picture of borrowing costs. This difference becomes important when interest is compounded more than once a year.

The effective annual interest rate (EIR) and nominal interest rate are two measures that represent loan costs differently.

The nominal interest rate is the stated annual rate without considering the impact of compounding. For example, a 12% nominal interest rate remains 12% whether the interest is compounded annually, quarterly, or monthly. This rate is often simpler but less accurate for reflecting true costs when interest compounds multiple times a year.

In contrast, the effective annual interest rate (EIR) accounts for compounding, showing the true cost of borrowing over a year. With frequent compounding, the EIR will be higher than the nominal rate, as interest accrues more frequently, leading to additional costs.

The key difference is that EIR reveals the actual interest paid due to compounding, making it more accurate for comparing loans. Understanding EIR versus nominal rates helps borrowers evaluate the real impact of different loan terms.

The effective annual interest rate is useful when comparing loans, credit cards, and even investment products. It helps borrowers see what they actually pay over a year, rather than just the advertised rate.

For personal loans, EIR highlights the true cost and supports better financial planning. To understand where you stand before moving ahead, it is useful to check your eligibility and see how your profile aligns with the lender’s criteria.

While the effective annual rate is helpful, it has some limits. It assumes a fixed interest rate for the entire year and does not include processing fees or other charges.

For loans with changing or promotional rates, the EIR may not fully reflect the total cost. Even so, it remains a useful comparison tool for standard, fixed-rate loans.

Nominal interest rates offer a basic view, but the effective annual rate gives a clearer and more accurate picture by factoring in compounding. Understanding EAR helps borrowers plan better and compare loans wisely.

If you are planning to manage expenses or consolidate costs, Bajaj Finance Limited offers competitive interest rates on personal loans. Apply today and manage your finances with greater confidence.

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