1. What is the Effective Annual Rate?

The Effective Annual Rate (EAR) is the actual interest rate that an investor earns or pays in a year after accounting for compounding. It provides a way to compare different mortgage or loan offers that may compound interest at different intervals.

2. How Does the Calculator Work?

The calculator uses the EAR formula:

Where:

• \( i \) — Nominal interest rate (decimal)
• \( n \) — Number of compounding periods per year

Explanation: The formula accounts for the effect of compounding, showing the true annual cost or return of a financial product.

3. Importance of EAR Calculation

Details: EAR is crucial for comparing different mortgage or loan options with different compounding periods. It helps borrowers understand the true cost of borrowing and investors understand their actual returns.

4. Using the Calculator

Tips: Enter the nominal interest rate as a decimal (e.g., 5% = 0.05) and the number of compounding periods per year (e.g., monthly = 12, quarterly = 4).

5. Frequently Asked Questions (FAQ)

Q1: Why is EAR higher than the nominal rate?
A: EAR accounts for compounding - the more frequently interest is compounded, the higher the EAR will be compared to the nominal rate.

Q2: How does compounding frequency affect EAR?
A: More frequent compounding (e.g., daily vs. monthly) results in a higher EAR for the same nominal rate.

Q3: What's the difference between APR and EAR?
A: APR is the nominal rate (doesn't account for compounding), while EAR is the actual rate including compounding effects.

Q4: When is EAR most important?
A: Most important when comparing loans/investments with different compounding periods or when compounding is frequent.

Q5: What's a typical EAR range for mortgages?
A: Current mortgage EARs typically range from about 3% to 8%, depending on market conditions and borrower credit.