When the terms annual percentage yield APY and APR are thrown around, it’s easy to become perplexed. You’ve probably come across these acronyms while opening new financial accounts or reviewing the terms of existing ones, but what do they all mean? What is the distinction between APY and APR?
In its most basic form, APY refers to what you earn on cash saved in a savings account, whereas APR refers to what you owe when you borrow. While it may sound like something from an advanced finance class, understanding the difference between APY and APR can help you make smart financial decisions when it comes to the importance of saving for financial goals and managing your debt.
Now, get ready for a deep dive into APY vs. APR:
What exactly is APY?
The annual percentage yield (APY) is the total amount of interest earned on a deposit account each year. You may not consider yourself a lender, but if you have a savings account, you are. The bank is basically compensating you for lending them money. The following bank accounts are frequently associated with an APY:
- Accounts for saving
- Money market funds
- Deposit certificates (CDs)
The APY is calculated using an account’s interest rate as well as how frequently the interest compounds. According to Justin Pritchard, an independent financial planner with Approach Financial in Montrose, Colorado, one of the key differences between APY and APR is that APY considers compounding. (APR only displays the annual interest on an account, not whether or not the interest compounds.)
For example, if you open online savings account with a 2.10 percent APY and deposit $15,000, you will have earned a total of $1,644 in interest after five years. 1 Your total annual interest earned would be as follows:
1 year: $315
2 years: $637
3 years: $966
4 years: $1,301
5 years: $1,644
What you should know when comparing APYs
Once you’ve figured out “what is APY?” Comparing the APYs on various accounts will help to find out how much money you can earn. If the numbers begin to make you dizzy, a savings calculator can help. The Discover savings calculator, for example, can help you calculate how much interest you’ll earn each year based on APY, starting balance, and time frame.
When looking for a new account, don’t give up after comparing only the APY. While it’s a good predictor of future returns, the APY does not account for potential fees.
What exactly is APR?
In light of our discussion of what APY is, let’s take a look at what APR is ? The annual percentage rate (APR) is the total amount of interest paid on an installment loan or revolving line of credit. “If you’re getting a loan, that’s usually the number you’ll see,” says Goodge of APR.
When comparing APY and APR, keep in mind that an APR may be associated with:
- Store cards and credit cards
- Personal, auto, and student loans
Credit lines, including home equity lines of credit (HELOCs) and personal credit lines
When deciding on a new credit card or loan, the APR of the account can be more telling than the interest rate. While APR is based on the interest rate, it may also include some of the lender’s fees, points, and other credit-related costs, according to Goodge.
What you should know when comparing APRs
Comparing only the APR on a new credit card or loan may not tell you the whole borrowing story, similar to comparing only the APYs on deposit accounts. Different charges may be included by lenders when calculating APR.
According to Pritchard, you should check which fees are included when comparing quotes from different lenders.
When comparing APY and APR, keep in mind that a loan’s APR is calculated assuming you’ll pay it off over the entire term. If you’re comparing 30-year mortgages but plan to move in five years, you should recalculate the APR to account for the shorter term. You might discover that a loan with fewer upfront fees ends up being less expensive, even if it has a higher advertised APR.
APY versus APR
When looking into new financial accounts, APY will be a consideration when comparing different types of savings accounts, whereas APR will influence your credit terms. As long as you keep all of the variables and differences between APY and APR in mind, you can think of the interest rate as a starting point for comparison when shopping for savings and credit options.