Gross interest is the annual payment on an investment before taxes or deductions. Net interest is the payment after deductions. Gross interest is calculated by applying the interest rate to the initial principal. Gross interest should not be confused with the Annual Gross Equivalency Rate (AER), which is a virtual fee for investments paid on a non-annual basis.
Gross interest is the money paid annually on an investment, calculated before taxes or other deductions are taken out. For example, if an investment pays 10% annual interest, then the value of that percentage, based on the original principal, is the gross interest. This is in contrast to net interest, which is the value paid on an investment after necessary deductions, such as taxes, have been made. The term should not be confused with the Annual Gross Equivalency Rate (AER), which is a value that represents the annual rate of an investment that actually pays differently, such as quarterly payments.
The gross interest on an investment is one of the simplest types of payments that can be determined. This is calculated by simply taking the initial principal in an investment and applying the gross rate to that security. For example, if someone has an investment of $100 US dollars (USD) in a bond that pays 8% per year, which is the interest rate, then they would earn $8 USD gross interest each year. Any other deductions that may apply to that return, such as taxes or service fees, have no impact on the gross value.
Unlike gross interest on an investment, net interest refers to payments that are earned with consideration of applicable deductions. There are a number of reasons why net amounts may vary from gross values, usually due to taxes or agent fees. In the example above of an 8% tax on an investment, there may be a 25% tax rate on that return. This would mean that even though $8 USD is earned in gross interest, after tax it would only represent $6 USD in net earnings.
Although similar in name, gross interest on an investment should not be confused with a gross annual equivalent rate. This is a rate determined for an investment that is paid on a non-annual basis, such as a quarterly return, when adjusted for annual payment. It is essentially a virtual fee that is not actually paid for an investment, but allows for easier comparisons between different opportunities.
The gross AER is higher than the gross return on an investment, since interest is earned more than once in a year. An investment with quarterly returns, for example, pays off four times in a year. The second payment accrues additional interest based on the principal plus the first interest payment. This continues with the third and fourth performance of the year, so the interest is compounded.
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