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.
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.
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.
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.
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.