If you’ve ever tried to compare rates on auto loans, credit cards, home loans or savings accounts, you’ve probably seen two terms consistently pop up: APR, also known as annual percentage rate, and APY, or annual percentage yield. Do you know the difference? Learn these common money terms to navigate your financial future with confidence.
What is APR?
Annual percentage rate represents the total cost of a loan over one year. When you make loan payments, you don’t just pay principal and interest. The price might also include fees, points or other associated costs. APR factors in those costs to give you a more transparent picture of what you actually pay, making it easier to compare loan options.
APR vs. interest rate
Your loan’s interest rate is the percentage of the principal you’ll pay in interest to your lender. It gives you a basic idea of how much it will cost to borrow money, but APR takes it a step further. Because it includes interest plus fees and other charges, you get a more comprehensive view of your costs.
What is APY?
Annual percentage yield represents the total amount of interest on your deposits over a year. In addition to the account’s interest rate, APY also includes the frequency of compounding interest to give you the most accurate representation of what you earn.
Like APR, this figure is used to standardize comparisons, giving you a better idea of which account offers the best return for your money.
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APY vs. interest rate
Your account’s interest rate tells you the base rate at which your money will grow. But how often that interest compounds can make a major difference. Say you found an account that offered 5.10% interest compounded annually and one that paid 5.00% interest compounded daily. Which will make you more over time? By calculating the APY, you can see that the latter actually makes more — its APY is 5.12%, compared to 5.10% for the former.
Key difference between APR and APY
APR is used for money you borrow, such as on a loan or credit card. It represents what you pay. APY is used for money you deposit into a savings account, certificate of deposit or other deposit account. It represents what you earn. Both are used to make objective comparisons easier between financial products.
Calculating APR vs. APY
Both APR and APY are calculated using industry-standard formulas. Math not your thing? Use our calculator to compare how different variables affect your APR and APY:
How to calculate APR
The APR formula requires you to first calculate your periodic interest rate. That equation is: [(loan fees + additional expenses) / loan principal] / the number of days in your loan term. Use that number in the following formula:
APR = (Periodic interest rate × 365) × 100
How to calculate APY
To calculate APY, you need to know your interest rate and the number of compounding periods per year. Then, plug them into this formula, where R represents the interest rate and N represents the compounding periods:
APY = (1 + R/N)^N – 1
Practical tips for using APR and APY
Now that you understand what these terms mean, keep these tips in mind when you see APR and APY:
Compare products: APR is used to compare loans and credit cards. Use APY for savings accounts and CDs.
Consider compounding: More frequent compounding means your money adds up faster. With a higher APY, you can boost earnings.
Check terms: Even if you’ve got a grasp of APR and APY, always read the fine print to know exactly what terms apply.
Why it’s important to understand the differences
Understanding the nuances between APR and APY can help you better map out your financial future with a clear outlook on what you owe and what you earn. Remember, financial literacy is a lifelong journey. Staying curious and informed is key to working toward your financial goals.
