Enter the annual nominal rate and the number of compounding periods per year into the calculator to determine the effective interest rate.

## Effective Interest Rate Formula

The following formula is used to calculate an effective interest rate.

ER = (1 + i/n) ^ n - 1
• Where ER is the effective interest rate
• i is the nominal interest rate
• n is the number of compounding periods per year

## Effective Interest Rate Definition

The Effective Interest Rate (EIR) is a financial metric that measures the true cost of borrowing or the return on investment over a specified period.

It is derived by accounting for interest compounding within a given time frame. Rather than solely considering the nominal interest rate, the EIR reflects the actual interest earned or paid, including any additional fees or charges.

When analyzing financial products like loans or investments, the EIR provides a more accurate picture of their cost or return. By factoring in compounding, it captures the impact of interest being added or earned on previously accumulated interest. T

his compounding effect can significantly affect the overall cost of borrowing or the profitability of investments.

## Effective Interest Rate Example

How to calculate an effective interest rate.

1. First, determine the nominal rate.

For this example, we will say we are looking at a credit card with a monthly nominal rate of .15 (15%).

2. Next, determine the compounding periods per year.

Since the nominal rate is per month, the compounding period is 12 months per year.

3. Finally, calculate the effective interest rate.

Using the formula above we find the effective rate to be (1+.15/12)^12 – 1 = .1607

## FAQ

What is an effective interest rate?

Effective interest is the true annual interest rate of a loan or credit based on a nominal rate and number of compounding periods per year. Interest compounds each period, so the more compounding periods the higher the effective rate will be.