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Definition
The effective annual rate converts a rate that compounds more than once a year into a single annual figure. It answers: if interest is charged monthly, what would the equivalent once-a-year rate be? The formula is (1 + r/n)^n − 1, where r is the nominal rate and n the number of compounding periods.
In plain terms
It is the honest annual price. A 2% monthly overdraft is not 24% a year — compounded, it is about 26.8% EAR. The more often interest is applied, the wider the gap.
Why it matters for your company
Use the EAR to compare a revolving facility against a term loan, since they compound differently. On regulated overdrafts the FCA requires an EAR; on business lending, ask for it. See nominal rate and compounding frequency.
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