APR vs APY: What's the Difference and How Does It Work?
APY refers to the amount of interest earned on your savings and APR is how much interest you owe.
APR, which stands for Annual Percentage Rate, is the interest rate on an account plus any fees you’ll have to pay. It’s calculated on a yearly basis and shown as a percentage. APY, which stands for Annual Percentage Yield, is the rate you can earn on account over a year and it includes compound interest.
What are the differences between APR and APY in terms of interest rates?
Since the APR is going to give you an idea of the costs you’ll incur with a credit card or loan, you want that number to be low. In fact, when it comes to finding the best APR, you’ll want to look for the lowest number possible, and make sure you see the typical APR, not just an example prefaced with the words “as low as.” For APY, on the other hand, you’re looking to see how much interest you can gain from a potential account or investment. That means you’ll want the APY to be as high as possible.
What are the differences in calculating interest rates for APY and APR?
Both APY and APR are calculated based on interest rates, but they have additional factors, too. APYs give you the most accurate idea of an account’s earning potential, while APRs give an idea of what you could owe.
Since both are shown over a single year, they are more accurate than interest rate alone. Think of savings accounts with a higher interest rate for the first three months, or credit cards with 0% introductory rates. Comparing accounts on interest rates alone can be less accurate than when you use APR and APY.
What's the difference between compounding monthly vs. yearly?
The frequency of compounding impacts the principal balance. Let’s say you have a savings account with $5,000 in it and it earns a 2% APY compounded monthly. Assuming you do not make any additional deposits, at the end of one year the monthly compounded account would yield a balance of $5,100.92. If that same account were compounded annually, the balance at the end of the year would be $5,100.00. That’s an insignificant difference, but consider what happens if you were to deposit $100 a month to the accounts in each scenario. The account that’s compounded monthly would end the year with a balance of $6,311.98, while the annually compounded account would have $6,300.00. In other words, the higher the balance, the more frequency of compounding impacts the balance.
Can you compare the same type of interest rates for APR vs APY?
When you’re shopping for accounts, make sure that you compare the same type of interest rate. To see how two contenders stack up, make sure you’re looking at APY for both accounts, or APR for both, rather than one of each.