Finance term
EAR — Effective Annual Rate
Also known as: EAR, Effective Annual Rate, effective annual interest rate, annual equivalent rate, AER
Definition
The Effective Annual Rate (EAR) is the mathematically precise annualized cost of a loan or return on an investment, accounting for the effect of compounding within the year. Unlike APR (which is a nominal annualized rate), EAR reflects what you actually earn or pay when compounding occurs more frequently than annually.
Detailed explanation
EAR (also called Annual Equivalent Rate or AER in some markets) is the rate that, compounded once annually, produces the same result as the nominal rate compounded at its actual frequency. For borrowers, EAR is the true cost of credit when a loan compounds monthly, daily, or at any sub-annual frequency. For investors, EAR is the true return when interest compounds intra-year.
Formula: EAR = (1 + r/n)^n - 1, where r is the nominal annual rate (APR) and n is the number of compounding periods per year. Examples: a 12% APR compounding monthly produces an EAR of (1 + 0.12/12)^12 - 1 = 12.68%. A 12% APR compounding daily produces (1 + 0.12/365)^365 - 1 = 12.75%.
EAR vs. APR: The U.S. regulatory framework primarily uses APR (Annual Percentage Rate) for loan disclosures under TILA/Regulation Z (Truth in Lending Act, 15 U.S.C. § 1601; Federal Reserve Regulation Z at federalreserve.gov/regreform/regz.htm). APR is the nominal rate plus certain fees, annualized — it does not account for compounding. APY (Annual Percentage Yield) is the deposit-side equivalent of EAR, required by the Truth in Savings Act (TISA, 12 U.S.C. § 4301) for deposit account disclosures.
For business borrowers, EAR matters most in these situations: (1) comparing a revolving line of credit (daily compounding) against a term loan (monthly compounding) at the same nominal APR — the line costs more per year; (2) evaluating invoice factoring or merchant cash advances where the implicit cost is very high and the compounding period is short; (3) international financing where EAR/AER is the standard disclosure (UK, EU) rather than APR.
◈ Worked example
- 12% APR (nominal), monthly compounding: EAR = (1 + 0.12/12)^12 - 1 = 12.68% — you pay 0.68% more per year than the headline rate suggests
- 24% APR (nominal), daily compounding (typical for credit cards): EAR = (1 + 0.24/365)^365 - 1 = 27.11% — the true annual cost is 3.11 percentage points above the stated APR
- SBA 7(a) loan at 10.5% APR (prime + 2.75%), monthly compounding: EAR = (1 + 0.105/12)^12 - 1 = 11.02% — small difference because SBA rates are low; the gap widens at higher nominal rates
Common questions
The most-asked questions about EAR — Effective Annual Rate — answered straightforwardly.
What is the difference between APR and EAR? +
APR (Annual Percentage Rate) is the nominal annualized rate — it does not factor in the effect of compounding within the year. EAR (Effective Annual Rate) does. U.S. loan disclosures use APR by law under TILA/Reg Z (federalreserve.gov/regreform/regz.htm). EAR is the mathematically precise cost. For low rates, the difference is small. For high-rate products (credit cards, MCAs, short-term loans), EAR is significantly higher than APR.
Is APY the same as EAR? +
Yes — APY (Annual Percentage Yield) and EAR use the same formula and represent the same concept: the true annualized rate after accounting for compounding. APY is the term used for deposit accounts (required under the Truth in Savings Act). EAR is the same concept applied to borrowing. The math is identical: (1 + r/n)^n - 1.
When should I use EAR instead of APR to compare loan offers? +
Use EAR when comparing loans with different compounding frequencies. If Loan A has a 10% APR compounding daily and Loan B has a 10.1% APR compounding annually, Loan A's EAR is 10.52% and Loan B's EAR is exactly 10.1% — Loan B is cheaper despite the higher headline APR. Also use EAR when comparing U.S. loan offers against UK/EU products quoted in AER.
Further reading
This glossary entry is educational content. ClearValue Lending is a business & personal financing platform — not a lender, broker, or financial advisor. Specific product terms vary by lender; verify with the lender or issuer before applying. See privacy policy.