Effective Interest


Nominal Interest Rate (i):                     %

Number of Times Compounded(n):               

(Annual=1, Semi-Annual=2, Quarterly=4, Monthly=12)

       

Effective Interest Rate (r):          %

The formula for Effective Interest Rate is the following:

r = (1 + i/n)n-1

r = Effective Annual Rate
i = Nominal Rate
n = Number of Compounding Periods per Year

Sample Effective Interest Rate Problem


Jayden is going to put his money in the bank that is offering 7% and it is compounded monthly, what is his effective interest rate?
His effective interest rate is 7.229%.

In looking at this, if you were to just calculate how much interest he would earn at 7%, he would make $1070. However if you consider the effect of compounding interest, he actually will make $1072.29. While this isn't significant, every dollar counts and this will add up over time.