Effective Interest Rate: What Your Loan Really Costs
The nominal interest rate on a loan or investment is rarely the full story. Compounding frequency changes how much you actually earn or owe. The effective interest rate (EIR) gives you the true annual cost.
What Is the Effective Interest Rate?
The effective interest rate (also called the effective annual rate or EAR) accounts for compounding within a year. A 12% nominal rate compounded monthly is actually 12.68% effective, because each month's interest earns interest in subsequent months.
The Formula
EIR = (1 + r/n)^n − 1, where r is the nominal rate and n is the number of compounding periods per year. For daily compounding (n=365), a 10% nominal rate becomes 10.52% effective. For monthly (n=12), it becomes 10.47%.
Why It Matters for Borrowers
When comparing savings accounts or investment products, always compare effective rates — not nominal. A savings account with 4.8% compounded monthly is better than one with 4.9% compounded annually. For loans, higher compounding frequency means you pay more total interest.
Using the Calculator
Enter your nominal interest rate and select your compounding frequency. The calculator shows the effective annual rate, the difference from the nominal rate, and the total cost impact over your loan or investment term.
Try the Effective Interest Rate Calculator
Calculate the Effective Annual Rate (EAR) for any nominal rate and compounding frequency.
Open Calculator →Frequently Asked Questions
What's the difference between APR and EIR?
APR includes fees in the rate calculation. EIR focuses purely on compounding effects. A loan can have both — APR shows total cost, EIR shows the compounding impact of the rate itself.
Which compounding frequency should I assume?
Most US mortgages compound monthly. Credit cards often compound daily. Savings accounts vary — read your account disclosure or use the actual compounding frequency stated by your bank.
Does the effective rate change if I pay early?
Yes. If you pay off a loan before maturity, the effective cost changes because fewer compounding periods occur. Our calculator shows results over the full term.