APR vs APY: what is the difference?

credit card or loan agreement

Compare APR and APY to get the most out of your money

You might already have seen the terms APR vs. APY in your credit card or loan agreement. But do you know what they mean and why they are important to your finances?

In this article, we’ll answer those questions and help you understand APR and APY and how they can affect your finances. Keep reading!

What is APR?

The Annual Percentage Rate or APR means the interest rate a borrower will pay on loan. By loans, you can understand:

  • Credit cards;
  • Mortgages;
  • Home loans, personal loans, student loans;
  • A personal credit line, and more.

There are two different types of APR. They are called fixed and variable.

The first one (fixed APR) is an annual percentage that doesn’t change regardless of the market rates.

It stays the same during the loan, so you won’t have to worry about extra costs.

You can calculate the APR online for free, don’t worry. Many websites can do that for you.

On the other hand, a variable APR changes over time. Normally the percentage varies from loan to loan.

For example, a credit card APR for purchase may range from 5 to 30%. Usually, variable APRs are less expensive than fixed APRs because they oscillate more.

APRs are important features to consider in a card because they can greatly impact your monthly payments. So let’s learn how to calculate it.

How APR is calculated

To calculate the annual percentage rate, it’s important to consider the following:

  • Interest: total amount paid over the loan life;
  • Principal: the amount of the loan;
  • How long is the loan term: the length in days;
  • Fees and other costs associated with the loan.

The APR is calculated by taking the total interest and fees paid during a year and dividing it by the borrowed amount in total.

For example, if you borrow $100 at an APR of 10%, you would owe $10 in interest at the end of the year.

APRs can be helpful when comparing the cost of different loans, but it’s important to remember that it’s only a measure of the interest and fees paid, not the total cost of the loan.

So, before you apply for a loan, consider the full cost, including any upfront fees, monthly payments, and early repayment penalties.

What is APY?

APY stands for annual percentage yield. It’s a way to measure how much interest you’ll earn on your deposit account for a year.

It can also be called EAR or effective annual rate. So, APY is typically used when referring to interest rates paid on the money market, savings accounts, and certificates of deposit (CDs).

This percentage is important since it includes the effects of compounding interest, which is you can earn not only on the original deposit amount but also on the accumulated over time.

Then the higher the APY, the faster your money will grow. So, if you are looking for savings, you should look for the best APY accounts.

In addition, APY is also important to understand because it provides a more accurate picture of the true cost of an investment than the interest rate alone.

How APY is calculated

APY is a way to make sure that the rate of return is fair. It does this by stating how much you will earn in compound interest if you deposit the money for one year.

The formula to calculate the APY is:

APY= (1 + r/n )n – 1

What is the difference between APR and APY

When discussing the opposition APR vs. APY, it’s crucial to comprehend that both are forms of interest, but how they’re calculated is different. 

Let’s look at the difference between them in a nutshell:

APR (annual percentage rate)APY ( annual percentage yield)
Measures the interest chargedMeasures the interest earned
Credit accounts and loansSavings and deposit accounts

On the one hand, APR measures the interest rate charged on a loan, indicating the loan percentage amount.

Remember that the APR doesn’t consider the effect of compound interest, so it will be equal to or lower than the APY.

On the other hand, APY is a measure of the total earned on an investment over time, considering compound interest’s effects.

How can APR and APY impact your finances?

APR and APY are two ways to measure the cost of borrowing money or the return on investment, respectively.

As we mentioned before, the main difference between APR and APY is that APR won’t suffer any effects of compounding, while APY will.

Then when it comes to your finances, it’s important to be aware of the difference between them. Here are four ways that APR and APY can impact your finances:

1. The higher the APR, the more you’ll pay in interest on a loan or credit card balance

For example, if you have a balance of $1000 on a credit card with an APR of 10%, you’ll pay $100 in interest for a year.

However, if you have a balance of $1000 on a credit card with an APR of 20%, you’ll pay $200 in interest over a year.

2. The higher the APY, the more you’ll earn on investments over time

It is because when you invest, you’re essentially lending your money to an organization or individual and earning interest on that loan.

The APY is the interest rate you earn on that investment, so the higher the APY, the more you’ll earn in interest over time.

3. Comparing two loans

When comparing two loans with different APRs, the one with the lower rate will usually be preferable.

Finally, be sure to check both the APR and APY when comparing financial products, as either can significantly impact your bottom line.

By understanding how APR and APY work, you can make more informed decisions about using credit and investing your money. We hope this article has cleared your mind and might have contributed to your finances. Thanks for reading!