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