Understanding the Difference Between APR and APY
Financial terms can be confusing, and two phrases that often come up when dealing with interest rates are APR and APY. While they may sound similar, APR and APY actually refer to different aspects of interest rates.
What is APR?
APR stands for Annual Percentage Rate, and it is typically used when borrowing money. This rate represents the yearly interest rate a borrower must pay on their loan, including any fees or charges associated with it.
For example, if you take out a $10,000 loan with an APR of 5%, you will have to pay $500 in interest charges per year. However, if the loan also comes with a $200 origination fee, the APR will be higher since the total cost of the loan is more than $10,000.
It’s important to note that while APR takes into account the interest charged on a loan, it does not include the effect of compounding interest over the course of the year. That’s where APY comes in.
What is APY?
APY stands for Annual Percentage Yield, and is often used when depositing money into a savings account, money market account, or certificate of deposit. This rate represents the amount of money earned on an account through compounding interest over the course of a year.
For example, if you were to deposit $1,000 into a savings account with an APY of 2%, after one year you would earn $20 in interest. However, if the account had a monthly compounded interest rate, you would actually earn slightly more than $20 due to the interest earned on the interest.
It’s important to note that because APY is based on compounding interest, it is generally higher than APR, particularly with longer-term investments like CDs.
Conclusion
In summary, the main difference between APR and APY is that APR is used to represent the yearly interest rate a borrower must pay on a loan, while APY represents the amount of interest earned on an account through compounding interest over the course of a year. Understanding the distinction between these two rates can help you make better-informed financial decisions when borrowing or investing.
Table difference between apr and apy
| Term | Definition |
|---|---|
| APR | Annual Percentage Rate. The interest rate charged on a loan or credit card on an annual basis. It includes the interest rate plus any additional fees or charges incurred. |
| APY | Annual Percentage Yield. The amount of interest earned on a savings account or investment on an annual basis. It takes into account the interest rate as well as how often interest is compounded. |