18 August 2011

Lesson 3: AER - Truth Revealed! Fixed Deposits Annual Interest Rate

Again, please read the basic difference between APR and AER before continue reading the below.

Refer to the annual interest rate for Maybank FD rates.

Assume RM 30,000 placed as FD for period of 1 month. Principal and interest will be credited to savings account after maturity.

Your earned interest would be RM 73.97 by the end of the month

You asked, how come? If it's 3% per annum, monthly interest rate based on principal of RM 30,000 should (3/12)% x 30,000 = RM 75.

The truth here is that 3% annual rate is actually AER, which is your total return based on RM 30,000 if and only if your monthly interest earned is added into your initial principal, and gets carried forward to subsequent month, for a total of 12 months repetitively.

Using FV function in excel, where nper=12, i=0.00246625 and PV=-30,000, you get FV=30,900.00.You earn interest of RM 300, which is 3% of the principal.

In other words, you only earn the quoted 3% per annum if and only if your monthly interest is added to the principal and carried forward to the subsequent months for 12 months.You DO NOT actually get 3% per annum out of your principal if the monthly interest is credited to your savings account every month for 12 months.

Example, 73.97 x 12 = 887.64. This is only 2.959% of 30,000!
Now using AER to APR conversion formula here, you get APR = 2.959%, which is exactly 887.64 over 30,000. 

In this scenario, it is in the bank's best interest to quote you the AER, instead of APR. They know that when you are the lender, you are seeking the highest rate of interest possible to entice you. 

Feeling cheated? Yes. Dubious marketing? Double yes. Why can't they just present the facts just as it is? How many of non-personal-finance-savvy individuals know about this?

Here's a quote I read somewhere:

Other industries look after loyal customers. Banks do the reverse; rewarding new customers with the best deals while neglecting their existing ones, regardless of how long you have banked with them.

*AER and EAR are essentially synonymous. EAR is a term adopted for overdraft calculation.

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