Effective Rate

1. Rate of interest paid on a loan, or earned on an interest-bearing deposit, as distinguished from the Nominal Rate. In a bank loan, it is the Annual Percentage Rate. See also Add-on Interest; Annual Percentage Yield; Simple Interest.

2. Investor's yield realized on a bond or security, which is different from the Coupon Rate. The effective rate takes into account the price paid, the time to maturity, and the amortization of premium or accretion of a discount. Also called effective yield.

3. Weighted average cost of Federal Funds purchased in the inter-bank market, calculated by the Federal Reserve Bank of New York. Banks that are short in the Reserve Accounts are charged at a rate equal to the effective rate of the Federal Funds.

Another name for annual percentage rate that refers to the amount of yearly interest to be charged by a lender on the money borrowed by a debtor.

In federal income tax law, the actual tax rate that an individual taxpayer pays based upon his or her taxable income.

Federal income tax laws increase the rate of taxation as a taxpayer reaches certain marginal income levels. For example, taxpayers might pay a tax rate of 20 percent on the first $10,000 of taxable income. Thereafter, any increase in income up to an additional $5,000 might be taxable at a rate of 22 percent on that $5,000. The effective rate of tax is computed by dividing the total amount of tax paid by the total of the person's taxable income, adding the tax paid on the person's first $10,000 at a 20 percent rate to the tax paid on the next $5,000 that is at a 22 percent rate. The effective rate is not an average of the tax rates imposed since the average does not take into account the differences in the marginal income levels. A taxpayer's effective tax rate is, however, more than the person's bottom marginal rate but less than his or her top marginal rate.