Effective Interest Rate Key Terms

Learn the ABCs of effective interest rate key terms

By Jennifer Ehlenfeldt, Freelance Writer

The effective interest rate is used as a calculation to determine a more accurate interest rate over a period of time. Investment interest rates, also called effective interest rates, are determined for a period of time or life of the investment.

In the opposite token, as a borrower, the effective interest rate is the annual rate of interest you will pay on a loan. If you understand the basic investing and borrowing terms that go with effective interest rates, you'll be able to better understand how interest will affect your investments or loans.

Installment

An installment is the regular payment made on a loan at a scheduled time.
Try: The term installment is defined at InvestorWords. You can also find terms related to "installment" here.

Annual equivalent rate (AER)

The annual equivalent rate, or AER, is calculated by using the effective interest rate. Loans with interest compounded at different intervals like daily, weekly or quarterly or annually are hard to compare. The AER converst these rates to an annual rate to make it easily compared.
Try: MortgageQnA defines annual equivalent rate. The glossary also has many other terms associated with the effective interest rate that may be useful.

Rate swap

An interest rate swap takes place when one interest rate is exchanged for a different one. Each is based on the same principal amount, but can change the way a loan is paid by lowering interest or changing to a floating payment option.
Try: Read the definition of rate swap and other financial terms at Investopedia.

Simple interest and compound interest

Simple interest is calculated using a single percentage of the principal amount, while compound interest is that paid on the principal plus previously paid interest amount.
Try: Read the definitions of simple and compound interest at Get Objects. Find out how simple or compound interest can be used to determine any effective interest rate.

Compound growth rate

The compound growth rate is a measurement of average growth over a set time. The assumption made with this figure is that the rate is constant in growth over time. The rate doesn't show big gains or losses in rate so it can be misleading.
Try: The term compound growth rate is explained in the Investor Glossary. Many other terms related to the effective interest rate are also available in the glossary.

Nominal interest rate

A nominal interest rate is one that does not adjust for inflation. A nominal rate can be calculated easily without adjusting to figure the effective interest rate.
Try: The definition of nominal interest rate is available at This Matter. The website gives an overview of the entire interest process.