What’s the difference between APR and APY besides one letter?

To most people knowing the difference between Annual Percentage Rate (APR) and Annual Percentage Yield (APY) doesn’t seem like a big deal, but that one letter at the end of those two acronyms can make a big difference financially. It’s important to note that knowing the difference between APR and APY could save consumers, hundreds and possibly thousands of dollars over time.

What is APR?
APR is mostly used when determining the interest that is owed on a loan including mortgage, automobile, credit card or other types of loans. It is the annual rate of interest that is paid, so it is simply the rate you pay to borrow money on an annual basis.

What is APY?
APY on the other hand, is commonly used to define interest that is paid on savings and checking accounts, or any other type of interest-bearing account. The key with APY is the compounding interest, that is how often the interest is applied to the balance, which can range anywhere from daily to annually.

What’s the difference between them?
The biggest difference between APR and APY lies in how they relate to your savings or investment growth, or the cost of borrowing. APY includes interest paid on interest, so it is always higher than APR. So in essence, APY is more accurate to figure out how much money you will earn or owe over a set period of time and should be used when your shopping for interest-bearing accounts. Since APY includes interest paid on interest, the higher the APY is for saving accounts the better, but it should be lower for loans because interest is being paid on interest that is accrued – in other words, the higher the balance the more you will owe on the loan.

When financial institutions are seeking customers for interest-bearing investments, such as certificates of deposit or money market accounts, it is in their best interest to advertise their best APY and not APR. Since the APY is higher than the APR, it looks like a better investment for the consumer. For investments and savings, finding a high APY should be a priority because the higher the APY the more potential your money has to grow thanks to compounding.

The reverse would be true with APR in a borrowing scenario, on the other hand. If you’re getting a car loan, mortgage, credit card or any other type of financing, you’d want the APR to be as low as possible. The lower the APR, the less interest you’ll pay over the loan or line of credit’s repayment period.

Also, keep in mind that the APR, as it is associated with borrowing, may be variable or fixed. With a variable-rate, the interest rate on the loan balance changes as rates in the market change because they are tied to an index and this also changes your monthly payment. A fixed APR, by comparison, would stay the same for the entire length of the repayment term, allowing for predictability in your monthly payments and the total amount of interest paid.

So it is easy to see that one little letter can really make a big difference when it relates to your wealth.

To learn more about this topic, please visit our sponsors, Atlanta Postal Credit Union or Center Parc Credit Union– they’ll be happy to help with your specific questions.