A stated (nominal) rate ignores how often interest is added. If interest compounds more than once a year, you effectively earn — or pay — more than the stated figure, because each period's interest starts earning too.

The effective annual rate converts any nominal rate + frequency into the single annual rate that gives the same result, so 12% compounded monthly and 12.5% compounded annually can be compared directly.

Given: Nominal rate 12% p.a., compounded monthly (n = 12)

i/n = 0.12/12 = 0.01  ·  EAR = (1.01)¹² − 1 = 1.126825 − 1

EAR = 12.683% — that is 0.683 percentage points above the stated 12%.

On ₹100,000, one year's interest is ₹12,683 instead of ₹12,000.

• The gap between nominal and effective widens as the rate rises and as compounding gets more frequent.
• Continuous compounding is the theoretical maximum: EAR = eⁱ − 1.
• EAR is not the same as APR — APR usually includes fees but may ignore compounding; EAR captures compounding only.
• Always compare two offers on the same basis before deciding.

EAR vs APY?
Same thing — APY is the deposit-side name for the effective annual rate.

Why is my loan costlier than the stated rate?
Because monthly compounding (and any fees) push the effective rate above the nominal one.

When are nominal and effective equal?
Only when compounding is annual (n = 1).