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# Effective Interest Rate Calculator

Table of contents

What is effective interest rate?The effective interest rate formula - How to calculate the effective interest rate on loan?How to find the effective interest rate? — nominal vs. effective interest rateHow to use the effective interest rate calculatorFAQs

The effective interest rate calculator, or the effective annual interest rate calculator, is a simple tool that finds the effective interest rate of savings or a loan.

In the following, you can learn what is the effective interest rate, how to calculate effective interest rate on a loan with the effective interest rate formula, and what is the difference between nominal vs. effective interest rate.

## What is effective interest rate?

The effective interest rate (EIR) is an annual rate that reflects the effect of compounding in a year and results in the same future value of the money as compounding at the periodic rate for m times a year.

For example, if you have a credit card that has a 36 percent annual interest rate, but interest is calculated and added to your balance daily, your daily interest rate is 0.1 percent (36% / 360 = 0.1%), and compounding happens each day on a new balance (m = 360). When interest addition and recalculation occur more often than once a year, the annual growth on your balance will be larger than what the annual interest rate suggests, resulting in a higher finance charge (in our example, 43.307%).

When you have a nest egg or investment, however, the effect of compounding becomes your friend. In this case, the more frequently interest is added to your money, the more interest that is earned on interest, meaning you get even more money. Therefore, the higher the compounding frequency, the higher the future value (FV) of your investment. If you are wondering how different compounding frequencies affect future values, check the table in our EAR calculator, where you can see more details on this subject.

## The effective interest rate formula - How to calculate the effective interest rate on loan?

The EIR formula in finance takes the following general form:

EIR = (1 + r / m)m − 1

where:

• EIR — Effective interest rate;
• r — Annual interest rate, which is the nominal interest rate in percent, also called the stated or quoted rate; and
• m — Compounding periods, which is the number of times compounding occurs in a year. In other words, the period after which the interest will be calculated on the principal amount and then added to it (capitalized on it).

If the compound frequency is continuous, you need to apply another equation:

EIR = em − 1

where e stands for the constant of the exponent.

Note that continuous compounding rarely occurs on loans or other financial instruments. For example, a mortgage loan typically has monthly or semi-annual compounding, while credit card interest is applied daily in most cases.

## How to find the effective interest rate? — nominal vs. effective interest rate

The best way to illustrate the difference between nominal vs. effective interest rate is to take a real-world example. Let's say you have 10,000 dollars that you would like to invest for your retirement.

You have two options:

1. Deposit in a bank that offers a 3 percent annual rate compounded monthly; or
2. Place it in an investment fund that offers the same annual rate but is compounded daily.

With which option would you be better off?

To answer this question, you must convert the annual rates of each scenario into effective interest rates.

So, how to find effective interest rate in this case? By applying the effective interest rate formula, the two scenarios result in the following effective interest rates:

1. EIR = (1 + 0.03 / 12)12− 1 = 3.0416%
2. EIR = (1 + 0.03 / 365.242)365.242 − 1 = 3.0453%

The investment fund's higher effective interest rate suggests that you would earn more interest in that case. You may think that the small difference is irrelevant. Still, it can result in large differences in your investment's future value in the longer-term. If you are curious how, try out our savings goal calculator, where you can follow the long-term progress of your savings.

As you can see by now, expressing the nominal annual rate in effective interest rate provides a useful way to compare the effective costs or earnings of different loans or return rates in investments where the compounding differs.

## How to use the effective interest rate calculator

To run this effective interest rate calculator, you need to set the below parameters, and you will receive your results immediately:

• Annual interest rate — Nominal interest in a year;
• Periodic rate — Rate charged by a lender or paid by a borrower for each period. In our effective interest rate calculator, the period refers to the compounding frequency, which coincides with the payment period;
• Compounding frequency — Number of times compounding occurs in a year; and
• Effective interest rate (EIR).

You can find the following additions in the Balances section of the calculator that you can use to compute future or present value with the given effective interest rate:

• Term;
• Initial balance; and
• Final balance.
FAQs

### How do I calculate the effective interest rate?

To calculate the effective interest rate, you can follow these steps:

1. Divide the annual interest rate by the number of compounding periods (i.e., the frequency of compounding within a year).

2. Add 1 to the result obtained from step 1.

3. Raise the result of step 2 to the power of the number of compounding periods.

4. Subtract 1 from the calculated value.

5. That's all! You have now calculated the effective interest rate.

### What is the effective interest rate of 12% compounded monthly?

The effective interest rate of 12%, compounded monthly, is approximately 12.683%, with a periodic rate of 1%. If you're looking for an easy way to calculate the effective interest rate, use Omni Calculator's effective interest rate calculator.

### What is the effective interest rate of 4% compounded quarterly?

The effective interest rate of 4%, compounded quarterly, is approximately 4.06% with a periodic rate of 1%. On the other hand, if compounded monthly, the effective interest rate would be approximately 4.074%, with a periodic rate of 0.3333%.

### What is the difference between stated interest rate and effective interest rate?

The stated interest rate is the nominal rate before compounding, whereas the effective interest rate considers compounding over time; hence, the effective interest rate can accurately reflect a financial instrument's actual cost or return.