When is the effective interest rate calculated?

The effective interest rate is primarily calculated every time interest is compounded. This rate takes into account the effects of compounding over a specific period, providing a more accurate representation of the actual interest earned or paid on an investment or loan.

When interest is compounded, it not only considers the principal but also the accumulated interest from previous periods. Since the effective interest rate reflects this cumulative effect, it is calculated at each compounding interval, whether that be monthly, quarterly, or annually. However, for loans and mortgages, the practical application commonly leads to the annual effective interest rate being prominently utilized in financial contexts, as this provides a clear annualized perspective on the cost of borrowing.

Options suggesting a fixed timeframe like weekly or monthly calculations do not capture the essence of the effective interest rate, as it varies based on the frequency of compounding, which is why it's more accurate to determine the effective interest rate every time compounding occurs, rather than on a specific schedule or frequency without relation to compounding.