# Effective Interest

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.