Trying to clearly communicate finance is tough enough, but sometimes rules intended to make things clearer do exactly the opposite. I’ve ranted before about the problems with meaningless APR rates on credit cards. Now I want to focus on the AER rate on savings…
What is the AER?
It stands for the Annual EquivalentRate, and it is meant to reflect the amount you’d earn on savings over a year to allow easy comparison. In effect it’s the savings equivalent of the APR.
What’s the problem?
While the AER tells you the rate over a year, many savings’ interest rates don’t work over a year, and the rate doesn’t actually mean anything – and can be a rate that in practice you’re never actually earning.
Let me give you an example:
- A savings account advertising 5% interest, but 4% of it is a bonus lasting just six months.
- A savings account advertising 3% interest for a year, including a 1% bonus.
If I were to quote the AER on these two accounts it would be roughly 3% (not quite exact due to monthly compounding). That’s because the AVERAGE rate earned over the year is 3% for both of them.
Yet I’d rather say (ignoring the fact they’re variable rate) one is “5% for six months, then drops to 1%, so ditch and switch” while the other is “3% for a year, then drops to 1%”.
That way you’d know that with the first you were getting a cracking rate for six months, then you should get out of there as it drops like a stone.
The problem in practice…
A few weeks ago I wrote this about top savings in the weekly email, and was caught out when writing about how to communicate the AER issue. Let’s see if you can spot the problem.
“New Top Easy Access Savings:
Two new top deals here, first Alliance & Leicester’s Online Saver Issue 7 pays 2.81% AER inc. 2.31% bonus for a year (min. £1,000).
To earn more you need to be prepared to operate by post, and accept a 3 withdrawal/year limit with the new West Bromwich Building Society Direct Bonus Account 2. It pays 3% inc a 1% bonus until 31 March 2011 (min £1,000).”
That’s because the online saver’s bonus lasts a year, therefore the AER represents the EXACT amount you’d earn during the time the bonus lasts for…
Yet with West Bromwich as the bonus lasts less than a year, the AER isn’t the same as the intro interest rate, after which you should ditch and switch. So does quoting the AER in this case actually help people?
Instead I’d compel companies to list the intial rate then the ‘go to’ rate, rather than this merged rate.
I’d love to know your views