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Both APR and APY are used to describe the interest you’ll pay on a loan or the interest you’ll make on a loan, in the case of opening a bank account.
Finance is a complicated field. It’s made even more so by the fact that banks and those who hand out loans are always looking to make their rates look as spiffy as possible, which means that trying to understand exactly how much you’ll be paying can be challenging.
However, the difference between APR and APY is a fairly basic one: it’s all about interest. APR, or annual percentage rate, doesn’t compound your interest, while APY, or annual percentage yield, does. In simplified terms, that means that with APY, you end up paying interest on your interest, while with APR, you don’t.
Key Takeaways:
| APR | APY |
|---|---|
| Annual percentage rate. | Annual percentage yield. |
| APR doesn’t compound interest. | APY does compound interest. |
| This is the better type of interest rate if you’re taking a loan. | This is the better type of interest rate if you’re giving a loan – such as putting your money into a bank account. |
| The number of periods in an APR is usually twelve, one per month, but the number of periods can vary. | Like APR, APY periods are usually monthly, but it’s important to check. Some will do more periods or fewer. |
What Is APR?
APR, short for annual percentage rate, is the percentage of your balance that a lender charges on a loan. This is most commonly seen on credit cards, which offer an APR on balances that you run on their card.
As the name suggests, APR is calculated on an annual basis. The percentage that is given on a credit card, for instance, 24%, is the interest that is paid annually. That means that you’re charged part of that every month – in this case, you’re charged 2% of your balance monthly.
So that means that if you run a credit card balance of $200, then you’ll be charged $48 for the year or $4 per month.
Many credit cards mention that their APR rate is variable. This means that if interest rates change, they can raise the interest on your balance. Also, a lot of them include penalty rates, which means that if you’re late on a payment, they can double your rate – or cancel their 0% introductory rate. Generally, a fixed APR rate is preferable, as it’s predictable.
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What Is APY?
APY, the shortened form of annual percentage yield, is a form of interest collection. APY takes into account the number of periods that interest is accrued and compounds that into the interest rate. That means, roughly, you end up paying interest on your interest when you have an APY.
This means that on a car loan or mortgage loan, an APY will cost you more in the long run than an APR. Especially on loan like a mortgage where you could be paying it off over the course of thirty years, the bit of extra interest can end up being a huge additional bill.
However, if you’re looking to invest your money, either in a bank or other investment system, an APY works in your favor. That means that you would make interest on your interest, so if you put your money into a CD account that has an APY rate, you’d get more interest back than if it were an APR.
APR vs. APY FAQ
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Can an APR loan have lower rates than an APY loan?
Due to the nature of the difference between APR and APY, an APY loan can’t have lower interest rates than an APR loan. APY loans take your interest rates and amount into account, therefore compounding your interest. That means that you end up paying rates on a higher amount of money, as the interest you’re charged is taken into account.
It may be possible, in certain circumstances, for an APY loan with much lower rates to end up costing you less than an APR with a very high percentage. However, the likelihood that you’d be offered such wildly different loan rates for the same purchase is vanishingly small.
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The formula for calculating APR is APR = ((interest rate + fees) / principal) / length of loan in days)) x 365 x 100. For those of us who forgot the order of operations, this is what you do:
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Add together the interest rate and fees.
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Divide that by the amount of the principal or amount of money you’ve been lent.
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Then, you divide that number by the length of the term of the loan in days.
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Follow that by multiplying it by 365 for the number of days in a year.
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The number you end up with should be a decimal. In order to translate that into a percentage, multiply it by one hundred.
There are also several online calculators that will do these calculations for you, just asking you to enter in the relevant numbers.
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The formula for calculating APY is APY = (1+r/n)n – 1. In this formula, r stands for the interest rate. It should be decimal form rather than percentage form, so you divide the percentage by 100. The variable n represents the number of compounding periods during the year.
This means that you will:
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Divide the rate in decimal form by the number of compounding periods in the year.
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Add one to that number.
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Put the resulting number to the power of the number of compounding periods in a month.
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And lastly, subtract one from that number.
As with APR, there are many online calculators that will do the calculations for you if you enter in the necessary variables.
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The rule of thumb is that if you’re borrowing, APR is better, and if you’re lending, APY is better. Since the interest is compounded in APY, you’d end up paying more in interest if you had that on, say, a car loan.
However, if you put your savings into a CD account and the interest is compounded, then you end up making more money in interest from the bank.
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Di has been a writer for more than half her life. Most of her writing so far has been fiction, and she’s gotten short stories published in online magazines Kzine and Silver Blade, as well as a flash fiction piece in the Bookends review. Di graduated from Mary Baldwin College (now University) with a degree in Psychology and Sociology.
