Debt Consolidation-Understanding APR , AER & EAR Easily

Whether it is financial jargon, legal jargon or computer "nerdy" jargon, it all comes down to the same result, which is that for those of us who are not specialists in the niche, dealing with jargon ensures that making an important decision will be more complicated that it needs to be. Take debt consolidation and debt management, normally when a person may need to consider one or either of these, how likely is it that they will fully understand the implications of the jargon that they must encounter to make a serious financial decision.

In fact when dealing with money, it becomes even more complicated because of the sets of abbreviated terms used when it comes to interest rates. Any idea of the difference between APR, AER or EAR; many people don't.

Take debt consolidation for example, when a financial service provider quotes a rate of interest for debt consolidation or other services, it is not very clear as to what you will have to pay or will be paid if you opt for the service. For instance when you look around for savings accounts, the quoted rates can be annual or monthly interest rates, and comparing of accounts with other service providers becomes difficult.

Even in the case of mortgages and loans, one company may quote a low interest rate but ask for fees upfront that are quite hefty, whereas another lender would ask for lower upfront fees but charge a higher interest rate.

It is best to have all these rates translate to APRs (annual percentage rates) or AERs (annual equivalent rates) before making a comparison. So never look at the rates that the company headlines, but rather at the AER or APR which are more indicative.

Annual Percentage Rate

The cost to borrow money is indicated by an APR and when you are looking for credit cards or personal loans this may be the quotation you receive from the companies or mortgage lenders. Such an APR will also include the upfront fees which will be charged. This would have been distributed over the period that you require to borrow the money for.

Thus an APR will be the proportion of the money borrowed that you would have to pay over the period of a year. So an APR of 9% can cost you £9 over the period of a year if you have borrowed £100.

In advertisements some service providers indicate a "typical APR", as most lenders prefer to set the interest rate based on the borrower's personal circumstances and credit record. But it is a fact that almost two thirds of customers are able to borrow funds at the quoted typical rate or even improve on it in some circumstances.

Some advertisements for mortgages will have the headline rate in addition to the APR. As administrative charges are charged on most mortgages, APRs are generally more than the headline rate.

Equivalent Annual Rate

If you are borrowing money in an overdraft, you will most often be quoted an EAR. EARs do not include any administrative charges when you are overdrawn. However such a rate will indicate the cost you would have to incur in case you are overdrawn for the period of a year.

Such calculations would include the cost of compounding, or interest on interest, the rate of interest and how often it will come into play during the year when you remain overdrawn.

Annual Equivalent Rate

This is the rate quoted by banks for crediting to current and savings accounts when they remain in credit. It is similar to EAR, but signifies interest earned and not one that you have to pay. This AER will indicate the interest you will earn over the period of a year, the periods when such interest will be paid and any effect of earning interest on the interest.

So this rate can let you know whether an interest rate where payments are paid monthly is superior to one where the interest is paid once a year.

So it follows that accounts where interest is paid monthly will be lower than the rates where such interest is paid once a year. If interest gets compounded then the net effect is you get higher returns than the interest paid once a year. For example if the interest rate offered is 6.25%, it may sound more attractive than a rate of 6.12% paid on a monthly basis. However because of the compounding effect the actual AER on the monthly interest payments may be 6.29% which is higher than the interest rate offered on annual payments.

AERs take into account the charges for withdrawal of money. This may be the fees you will be charged for any withdrawal and can be 30 days interest.

You should obtain clarification as to whether any introductory bonus offered has also been included in the AER. This will allow you to compare it correctly with any other account that offers the same rate of interest throughout the year.

So whether it is an item you are buying with a loan arrangement or you are considering debt consolidation as an option, make sure you feel fluent with the financial jargon, so you can make the best decisions.