APR vs APY

Difference Between APR and APY

APR(Annual Percentage Rate) and the APY(Annual Percentage Yield) are the two types of the interest rates where the APR is the rate which borrower have to pay for the financial products related to debt and does not consider effect compounding whereas APY is the rate which investor will earn on the financial products and it takes into account effect of compounding.

APR-vs-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.

APR-vs-APY-info

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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:

APR = Periodic Interest Rate * Number of Periods in 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 period. So, you end up paying more than what was advertised while selling you that loan product.

Whereas Annual Percentage Yield (APY) is calculated as:

APY = (1 + Periodic Interest Rate)Number of Periods in Year – 1

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

BasisAnnual Percentage Rate (APR)Annual Percentage Yield (APY)
DefinitionIt is the rate of interest paid or earned on investment without any effect of compounding of interest within the year.It is the rate of interest rate, on a normalized basis, taking into account the effect of compounding of interest within the year.
CalculationIt is calculated by multiplication of periodic interest rate and several periods in a year.It is calculated by adding 1 to the periodic interest rate and then multiplying the result to itself several times equal to the number of periods that the rate is applied less 1.
CompoundingIt does not consider the effect of compounding of interest.It considers the effect of compounding of interest.
UsageIt is mainly quoted by financial institutions to promote their financial products, which involve debt as it makes it easier to compare lenders and loan options.It is mainly quoted by financial institutions to promote their financial products, which do not involve debt as it represents a higher return to the investor.

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 DepositCertificate of deposit (CD) is a money market instrument issued by a bank to raise funds from the secondary money market. It is issued for a specific period for a fixed amount of money with a fixed rate of interest. It is an arrangement between the depositor of money and the bank.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.

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