Glossary
Effective Interest Rate
The rate you actually pay once compounding is applied — always equal to or higher than the quoted nominal rate..
The effective interest rate is the rate you actually pay once compounding is taken into account — the true annual cost of borrowing after interest is added to the balance more than once a year. It is equal to or higher than the nominal rate you are quoted, and the gap widens as the quoted rate rises.
How Canadian mortgages compound
Under the federal Interest Act, interest on a mortgage is calculated semi-annually, not in advance. A lender's quoted rate is therefore a nominal figure compounded twice a year, not a true annual rate. To set a payment schedule, the lender converts it into an equivalent monthly rate using (1 + i ÷ 2)^(1/6) − 1, where i is the quoted rate. The effective annual rate, (1 + i ÷ 2)² − 1, comes out slightly above the advertised number. See semi-annual compounding and our guide to why Canadian mortgages compound semi-annually.
Effective rate, quoted rate and APR
Three related numbers appear in the same conversation:
- Quoted (nominal) rate — the headline rate, compounded semi-annually.
- Effective annual rate — what that quoted rate becomes once semi-annual compounding is applied.
- Annual percentage rate (APR) — a broader disclosure required under federal cost-of-borrowing rules, which folds in certain fees so offers can be compared; see APR.
The quoted rate drives the payment, the effective rate shows the real annual cost, and the APR helps you compare lenders on a like-for-like basis. None of them is wrong; they answer different questions.
Why it matters
Compounding frequency changes the cost of identical nominal rates. A mortgage compounds semi-annually, while a home equity line of credit or secured line of credit typically compounds monthly or daily, so the same headline rate costs more on revolving credit. That difference matters when weighing whether to fold debt into a mortgage or leave it on a line of credit.
Compounding also feeds into prepayment penalties on fixed-rate mortgages, because the interest rate differential uses the lender's posted rate for a comparable term. Run the mortgage payment calculator to see the payment your quoted rate actually produces, and compare it with the nominal figure on the offer.
Frequently asked questions
Is the effective interest rate the same as the APR?
No. The effective rate reflects only compounding on the quoted nominal rate. The annual percentage rate is a broader disclosure required under federal cost-of-borrowing rules and can include certain fees, so it is usually higher. Use the APR to compare offers and the effective rate to understand how compounding affects what you pay.
Why is my mortgage rate compounded semi-annually instead of annually?
Mortgage interest in Canada is generally calculated semi-annually, not in advance, following the federal Interest Act. Interest is added to the balance twice a year rather than once, so the effective annual rate is slightly higher than the quoted nominal rate. Lenders convert the quoted rate to an equivalent monthly rate to set your payment.
Does the effective rate matter for a variable-rate mortgage?
Yes. A variable rate still compounds semi-annually, so the same conversion applies each time the rate changes. Your payment or amortization shifts based on the effective monthly equivalent of the current quoted rate, not on the headline number alone.
Sources
Related terms
- Annual Percentage Rate (APR) — The Annual Percentage Rate (APR) expresses the yearly cost of borrowing including certain fees, not just the interest rate, for easier comparison.
- Semi-Annual Compounding — Semi-annual compounding is the Canadian convention in which a mortgage rate quoted as an annual percentage is compounded twice a year rather than monthly or daily.
- Mortgage Interest — Mortgage interest is the cost a lender charges for borrowing mortgage money, expressed as an annual percentage rate applied to your outstanding balance.
- Posted Rate — A posted rate is the headline mortgage rate a lender publishes publicly, and it is usually higher than the discounted rate most borrowers actually receive.
- Fixed-Rate Mortgage — A fixed-rate mortgage keeps the same interest rate and the same scheduled payment for the entire mortgage term, so each payment is known in advance.