Difference Between APR and APY

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Annual Percentage Rate is the rate of interest paid or earned on investment without compounding of interest within the year. In contrast, the Annual Percentage Yield is the rate of interest on a normalized basis, taking into account compounding of interest within the year. Being aware of the nitty-gritty of financial jargon will help you calculate the interest rate that is relevant to you.

APR vs APY Infographics

Let’s see the top differences between APR vs APY.

Key Differences

The key differences are as follows –

When it comes to the Annual Percentage Rate (APR), it is the finance chargesFinance ChargesThe finance charge, also known as the cost of borrowing or cost of credit, is the accrued interest or fees that have been charged on the approved credit facility. Usually, this charge is a flat fee, but most of the time it is a percentage of the amount borrowed on an extended line of credit.read more expressed as an annual rate. It usually takes two forms:

  • First, the nominal APR, which is the simple interest rate for the whole year.Second, effective APR, which is the sum of fee and compound interestCompound InterestCompound interest is the interest charged on the sum of the principal amount and the total interest amassed on it so far. It plays a crucial role in generating higher rewards from an investment.read more rate for the year.

In short, APR refers to the interest rate you may owe to the lender. When banks advertise their loan products, they usually express interest in APR terms to make it seem like they have to pay a much lower interest rate. Hence APR will always be equal to or lesser than APY on a like-for-like basis in terms of interest rates. But there is a catch to this. It depends on how frequently the APR is applied to the loan balance.

For example, most of the credit card companies quote some x% APR on an annual basis. They divide this x% by 365 and apply this daily interest rate on the average credit card outstanding balance every date, after the grace periodGrace PeriodGrace periods are extra days given after the due date to undertake an unfulfilled obligation without penalties. They are a common instance in the financial world and are usually offered to clients who apply for a credit card, student loan, insurance, or mortgage to attract more customers.read more. So, you end up paying more than what was advertised while selling you that loan product.

Whereas Annual Percentage Yield (APY) is calculated as:

In short, APY refers to the interest rate you may earn on your investment. The compoundingCompoundingCompounding is a method of investing in which the income generated by an investment is reinvested, and the new principal amount is increased by the amount of income reinvested. Depending on the time period of deposit, interest is added to the principal amount.read more may happen on a daily, monthly, quarterly, or annual basis, which is then added to the principal balance. This interest is called compound interest, and the process is known as compounding.

The investment grows faster because every time the interest is calculated on the new balance, which includes the previous balance and the previous interest earned. So, the interest earned in dollar-terms increases every time.

Comparative Table

Conclusion

APR is the interest rate that a borrower will pay for debt-related financial products like credit cards or loans over one year. It usually does not involve the effect of the frequency of compounding of interest. One can not tell the complete story by looking at the APR figures as to how the bank will calculate the accruing interestAccruing InterestAccrued Interest is the unsettled interest amount which is either earned by the company or which is payable by the company within the same accounting period.read more. Also, its application depends on the type of financial product and transactions, as some might include fees and other financial charges and the interest component.

APY is the interest rate that an investor will earn on financial products like a certificate of depositCertificate Of DepositA certificate of deposit (CD) is an investment instrument mostly issued by banks, requiring investors to lock in funds for a fixed term to earn high returns. CDs essentially require investors to set aside their savings and leave them untouched for a fixed period.read more over one year. It does take into account the effect of how frequently the compounding occurs as it determines whether the investment will grow aggressively or sluggishly.

Always compare the same type of interest rates, i.e., compare APY to APY and APR to APR instead of comparing them across each other. Though when the compounding happens only once a year, then APR equals APY. The more frequent the compounding occurs, the faster the growth happens.

This has been a guide to APR vs. APY. Here we discuss the top 4 differences between Annual Percentage Rate and Annual Percentage Yield along with infographics and a comparative table. You may also have a look at the following articles –

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