What’s the difference between APR and APY?
An APR and APY are both used to calculate interest. The Annual Percentage Yield, or APY, is what you earn on a deposit account, like a savings account, over one year, and the Annual Percentage Rate, or APR, is the cost of borrowing money over one year.
An APR reflects the annual rate charged, expressed as a single percentage that represents the actual yearly cost over the term of the loan. The APR is based on the interest rate and, for some loans, it also incorporates any relevant fees, such as loan origination fees, closing costs, or other processing fees. If there are no fees, the APR equals the interest rate. The APR is calculated using the simple interest rate that a borrower will be charged over a year. That is, multiplying the principal you owe times the interest rate, times the term of the loan (the number of years the loan will be outstanding). The APR does not take into account the frequency of compounding interest.
APY means a percentage rate reflecting the total amount of interest paid on an account, based on the interest rate and the frequency of compounding for a 365-day period. An APY is usually larger than the interest rate because APYs may reflect compounded interest. This means interest is calculated based on the full amount of principal and on any interest that was not paid during the previous compounding period, generating ‘interest on interest.’ The more often the interest is compounded, the greater the return will be.
Both the APR and the APY are important to understand for managing finances. The more frequently the interest compounds, the greater the difference between APR and APY. Whether you are shopping for a loan, a credit card, or the highest rate of return on a deposit account, be mindful of the different rates quoted and make sure that you compare the same type of interest rate (APY or APR).