Difference Between APR and APY
Annual Percentage Rate (APR) and the Annual Percentage Yield (APY) are the two types of the interest rates where the Annual Percentage Rate is the rate which borrower have to pay for the financial products related to debt and does not consider effect compounding whereas is the rate which investor will earn on the financial products and it takes into account effect of compounding.
Annual Percentage Rate is the rate of interest paid or earned on investment without any effect of compounding of interest within the year whereas Annual Percentage Yield is the rate of interest, on a normalized basis, taking into account the effect of compounding of interest within the year. Being aware of the nitty-gritty of financial jargon will help you in calculating the interest rate that is actually relevant to you.
APR vs APY Infographics
The key differences are as follows –
When it comes to the Annual Percentage Rate (APR), it is actually the finance charges expressed as an annual rate. It usually takes two forms:
- First, nominal APR which is the simple interest rate for the whole year.
- Second, effective APR which is the sum of fee and compound interest 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 seems as if you have to pay a much smaller 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 actually 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. Now, 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:
In short, APY refers to the interest rate you may earn on your investment. The compounding 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.
Due to this, 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.
APR vs APY Comparative Table
|Basis||Annual Percentage Rate (APR)||Annual Percentage Yield (APY)|
|Definition||It 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.|
|Calculation||It is calculated by multiplication of periodic interest rate and a number of periods in a year.||It is calculated by adding 1 to periodic interest rate and then multiplying the result to itself a number of times equal to the number of periods that the rate is applied less 1.|
|Compounding||It does not take the effect of compounding of interest into consideration.||It takes the effect of compounding of interest into consideration.|
|Usage||It 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.|
APR is the interest rate that a borrower will pay for debt-related financial products like credit cards or loans over a period of one year. It usually does not involve the effect of the frequency of compounding of interest. One can not tell the complete story just by looking at the APR figures as to how the bank will calculate the accruing interest. Also, its application depends on the type of financial product and transactions as some might include fees and other financial charges as well along with the interest component.
APY is the interest rate that an investor will earn on financial products like a certificate of deposit over a period of one year. It does take into account the effect of how frequently the compounding occurs as it determines whether the investment will grow in an aggressive or sluggish manner.
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 APR and APY along with infographics and comparison table. You may also have a look at the following articles –