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
An effective interest rate is defined as the nominal rate of interest when compounded over a number of periods per year.
Effective Interest Rate Example
How to calculate an effective interest rate.
- 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%).
- Next, determine the compounding periods per year.
Since the nominal rate is per month, the compounding periods is 12 months per year.
- Finally, calculate the effective interest rate.
Using the formula above we find the effective rate to be (1+.15/12)^12 – 1 = .1607
An 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.