Difference Between APY & APR
Interest rates are sometimes reflected by APR (Annual Percentage Rate) and sometimes reflected by APY (Annual Percentage Yield). Knowing the difference between APR and APY will help you make better financial decisions.
Interest Rates
Interest is the cost paid for the use of another’s money on a temporary basis. When a party makes a loan or an investment, they expect to make money on the transaction. Without interest, there would be no instigation to lend or invest.
Financial institutions use APR and APY to show the interest either earned or owed. However the compounding principles involved with APR and APY can be a little misleading.
APR vs. APY
The difference between APR and APY is deceptively simple. Annual Percentage Rates (APR) tell you the annual interest rate paid on your investment. Annual Percentage Yield (APY) tells you the annual interest rate paid, but also takes into account how the interest is applied to the balance within that year.
So it’s really all about compounding interest. Depending on which side of the lending/investing line you are standing on, either APR quotes or APY quotes may look more or less appealing.
Quoting APR
If you are applying for a credit card, the credit company will likely quote you an APR instead of an APY. Lets say you have a credit card with a 1% monthly interest charge.
The APY, with monthly compounded interest reflected, would be 12.68% a year. But the APR only reflects the yearly compounded interest, so the APR would be 12%, and would appear less costly.
Quoting APY
On the other hand, if you are looking to open a savings account, the bank is more likely to quote an APY instead of an APR. Let’s say you open an account with $5,000. If the bank quotes the APR at 5%, it would reflect an annual earned interest of $250.
But reflecting inter-annual compounding interest, the APY for that account could be 5.20%, which would reflect an annual earned interest of $312, and would appear more beneficial.
Knowledge and Perspective
The bottom line is that financial institutions want you to think the percentages work to your advantage, so it’s up to you to be a savvy consumer.
When you are comparison-shopping for loans or investment, make sure you are comparing APY to APY and APR to APR. and remember which side your bread is buttered on. A little knowledge and perspective can go a long way to securing your financial future.
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