An effective annual rate is an interest rate in which the monthly interest is expressed as only being compounded annually.
When the effects of compounding over time are considered, an effective annual interest rate is the real return on a savings account or any interest-paying investment. It also reflects the actual percentage rate of interest owed on a loan, credit card, or other debt.
The true interest rate associated with an investment or loan is described by the effective annual interest rate. The effective annual interest rate's most important feature is that it takes into account the fact that more frequent compounding periods result in a higher effective interest rate.
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