When a bank offers you an account or a deposit, you will always see two different percentages. Confusing them tends to lead to poor decisions when comparing products.
What does each one mean?
- Nominal interest rate: the bare percentage the bank advertises. It does not take into account fees or the frequency at which interest is paid. It is the most visible figure, but the least useful for making comparisons. For example, in Spain it is called TIN and in the US, APR.
- Annual effective interest rate: what you actually earn or pay per year. It includes fees and the effect of payment frequency. It is the figure that allows you to compare products on a fair basis. For example, TAE in Spain, APY in the US, AER in the UK, EA in Colombia or GAT in Mexico.
💡 Example
Two banks offer the same 3% nominal interest rate. Bank A pays interest monthly; Bank B pays it at annual maturity. Bank A's effective interest rate is slightly higher because the monthly interest is automatically reinvested. Same nominal rate, but Bank A wins.
⚠️ Important
Practical rule: it is generally best to ignore the nominal interest rate when comparing products. It would be worth always looking at the annual effective interest rate (for example, TAE in Spain, APY in the US, EA in Colombia or GAT in Mexico) — it is the only figure that puts two different offers on an equal footing.