APR vs. APY: What’s the Difference?

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October 7, 2022

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APR vs. APY: What’s the Difference?

Annual percentage rate (APR) and annual percentage yield (APY) are two of the most common interest rates on the market. When it comes to financial matters, it's important to know the difference between APR and APY. Both are measures of interest, but they differ in how they're calculated. 

While the APR is used to determine the interest rate on a loan, APY is the interest rate an investor earns on an investment. In addition, APY factors in compound interest, unlike APR. Being able to understand the difference between the two can help you make informed decisions about your personal finances. 

What Are APR and APY?

APR, or annual percentage rate, is the simple interest rate you're charged on a loan. APY, or annual percentage yield, takes into account the effects of compounding interest. Used to calculate the interest rate on a loan, APR is the rate of interest you'll pay on a loan over a specified time period. 

On the other hand, APY is used for investments such as savings accounts, bonds, and certificates of deposit (CDs). In general, APY is more complex to calculate than APR, as it includes compound interest, and the higher the APY, the better the return.

When Should You Use APR Instead of APY?

The main difference between APR and APY is that APR doesn't take compounding interest into account, while APY does. This means that APR will often be lower than APY. So which one should you pay attention to? It depends on your situation. 

If you're trying to compare different investment options, for example, you'll want to look at APY since that's what will give you a true picture of your potential earnings. On the other hand, if you're trying to compare different loans, APR is a better measure to use.

APR is the annual rate of interest that is charged on a loan or investment. This means that if you have a loan with an APR of 10%t, you will be required to pay 10% interest on the loan each year. However, APR does not consider the effect of compound interest, which can significantly boost the total amount of interest paid over time. 

APY, on the other hand, takes compound interest into account and provides a more accurate reflection of the true cost of an investment or loan. For example, if you have a savings account with an APY of two percent, this means that your money will earn two percent interest each year. 

As a result, any interest earned will be added to your account balance and will earn interest in future years as well. This can result in an increase in your total earnings over time.

How To Calculate APR

When you’re trying to compare financial products, whether it’s a savings account, a loan, or a credit card, you’ll almost always see the term APR. This rate involves the yearly cost of borrowing money, including any fees charged by the lender. It’s expressed as a percentage. 

For example, let’s say you take out a loan for $100 with an APR of 10%. That means you’ll owe the lender $10 per year in interest and fees. To calculate APR, you need to know two things: The interest rate and the fees charged by the lender. 

The interest rate is the amount of interest charged on the loan, expressed as a percentage. In the example above, the interest rate is 10%. The fees can be either fixed or variable. Fixed means they don’t change over time, while variable means they could go up or down.

How To Calculate APY

To figure out APY, you'll need to know the interest rate and the number of compounding periods per year. The formula to determine APY is:

APY = (1 + C/B)^B - 1

In the formula, C is the interest rate and B is the number of compounding periods per year. For example, let's say you have a savings account with an interest rate of 2 percent, and it compounds monthly. Your APY would be:

APY = (1 + 0.02/12)^12 - 1 = 2.05 percent

The higher the APY, the more interest you'll earn over time. Certain investors may have a financial goal of earning the highest amount of interest.

What Is Considered a Good APR or APY?

Since every individual’s financial situation is different, a so-called good APR or APY will vary depending on the person and their means. In general, when taking out a loan or signing up for a credit card, it could help to have a low APR. This way, interest accumulates more slowly than if the rate were higher. 

As for APY, debt security like a bond or certificate of deposit (CD) or savings account should ideally have an interest rate that exceeds the national average. As of September 2022, the national deposit rate for a typical savings account is 0.17 percent, while a CD with a time span of 12 months has a rate of 0.60 percent. If an individual can find financial instruments that surpass these averages, they potentially come out ahead in terms of accrued interest and compound interest.

Which Interest Rate Applies to Cryptocurrency?

Certain cryptocurrency exchanges offer an introductory APY as a way to attract new investors. In the world of cryptocurrency, APY can be calculated using different operations, which include staking, factoring in decentralized finance (DeFi) liquidity pools, and farming. When selecting a crypto exchange, consider the APY. 

Be mindful of unsustainably high APYs, which can be a sign of a scam. To protect yourself from these fraudulent schemes, find a safe and reputable crypto platform. Some platforms offer APYs of up to 17%, which is higher than most traditional savings accounts.

Key Takeaways About APR vs. APY

When it comes to personal finance, it’s important to understand the difference between annual percentage rate (APR) and annual percentage yield (APY). Both terms refer to the interest that accrues on an investment or loan, but there is an important distinction between the two.

APR and APY refer to the interest that you earn on your cash while borrowing and saving, respectively. The APR is a one-time percentage that a lender will use to calculate the interest on a loan, while APY is the interest rate that an investor earns on their investment. 

In addition, APY takes compound interest into account because it includes the interest that you'll earn on your initial deposit and the interest it earns on it. This makes the APY a more accurate representation of the interest you'll earn on your investment. 

When Should You Use APR or APY? 

There's a time and a place for both APR and APY, and here's when to use each:

  • APR is best used to compare different loans with the same terms, like two 30-year fixed-rate mortgages.
  • APY is best used when comparing investments that have different compounding periods, like a one-year certificate of deposit (CD) and a five-year CD.

It's important to note that the APR is not a guarantee, and the loan's final interest rate will depend on the lender's final approval. Be mindful of the terms written in the contractual agreement before signing off on it, as it will have the approved interest rate, which may differ from the advertised APR.

What Is the Difference Between Calculating APR and APY?

In order to determine APR, you need to know the loan's term and its interest rate. If you're calculating APR on a credit card, be sure to account for the grace period. This is the period of time when you're not charged interest on your balance.

When you're calculating APY, you'll need to know the initial deposit, the length of the investment, and the interest rate. When determining which account to open, it's also important to consider the minimum deposit required and any fees associated with the account.

What Type of Investment Vehicle Offers High APY?

Innovative companies in the financial technology space like Compound Banc simplify the process of investing in real estate. Offering bonds backed by real estate assets, such as mortgages and commercial property, Compound Banc empowers the everyday individual to start investing with as little as $10, which can result in worthwhile returns. 

In fact, Compound Banc bondholders enjoy a seven percent APY stream of fixed income. At this rate, if someone saved up $1,000 to invest in bonds, they could earn more than $70 after 12 months with interest compounded daily. With excellent customer support and no hidden fees, Compound Banc levels the investment playing field, making it easier to achieve financial freedom. Join the Compound Banc community today.

Sources:

APR and APY Tools 

Compound Interest Calculator | Investor 

Opening a Bank Account | Consumer 

Credit cards | Consumer Financial Protection Bureau 

National Rates and Rate Caps | FDIC 

Crypto Assets | Investor 

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