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Gross interest is money that is paid out on an investment on an annual basis, which is calculated before any taxes or other deductions are subtracted. For example, if an investment pays out 10% interest annually, then the value of that percentage, based on the original capital, is the gross interest. This is in contrast to net interest, which is the value paid out on an investment after any necessary deductions, such as taxes, have been made. The term should not be confused with gross Annual Equivalent Rate (AER), which is a value that represents the annual rate on an investment that actually pays out on a different basis, 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 simply by using the initial capital on an investment and applying the gross rate to that value. For example, if someone has a $100 US Dollars (USD) investment in a bond that pays out at 8% annually, which is the interest rate, then a gross interest would be earned of $8 USD each year. Any other deductions that might apply to that return, such as taxes or service fees, have no impact on the gross value.
In contrast to gross interest on an investment, net interest refers to payments that are earned with consideration for applicable deductions. There are a number of different reasons why net amounts can vary from gross values, usually due to taxes or payments to agents. In the previous example of 8% rate on an investment, there may be a 25% tax rate on that return. This would mean that even though $8 USD are earned as gross interest, after taxes it would only represent $6 USD in net returns.
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 pays out on a basis other than annual, such as a quarterly return, when adjusted for annual payment. It is, essentially, a virtual rate that is not really paid on an investment, but allows comparisons to be more easily drawn between different opportunities.
The gross AER is higher than a gross return on an investment, since interest is earned more than once in a year. An investment with quarterly returns, for example, is paid out four times in one year. The second payment accrues additional interest based on the capital plus the first interest payment. This continues with the third and fourth returns for the year, so that the interest is compounded.
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