APR vs APY, What’s the Difference?
Unless you hold a degree in finance, you might not be familiar with the differences between APR and APY, as quoted by a financial institution. Although similar, knowing the difference can help you make better financial decisions.
*If you need to convert between APR and APY, check out ARPtoAPY.com.
What is APR?
APR (Annual Percentage Rate) is the annual rate of return — expressed as a percentage — before factoring in compound interest. You’ll run into this most often when considering terms for a loan. The APR make it simple to calculate your monthly payment.
Example:
Let’s say you would like to calculate how much interest will accrue today on your credit card. Your credit card charges 19.00% APR, compounds daily, and has a balance of $1000.
1. Express your APR as a decimal by dividing by 100.
2. Divide your APR by the number of compounding periods.
3. Multiply this number by your credit card balance.
Daily Interest Accrued = 1000 x 0.19 / 365
*In this case, your daily interest accrued would be $0.52. This amount would then be added to your balance for tomorrow’s calculation.
Benefits
- Considers total interest paid on a loan
- Best for calculating how much you owe each month
What is APY?
APY (Annual Percentage Yield) is the annual rate of return — expressed as a percentage — once you factor in compound interest. You’ll run into this most often when considering deposit accounts, and how much you’ll earn on your deposit.
Example:
Let’s say you want to calculate how much interest your savings account will pay you after one year. Your savings account pays 2.00% APY, and you have a balance of $1000.
- Express your APY as a decimal by dividing by 100.
- Multiply this number by your account balance.
Expected Annual Interest = 1000 x 0.02
*In this case, your expected annual interest accrued would be $20.00. Your expected balance at the end of the year would be $1020.00.
Benefits
- Accounts for differences in compounding frequencies
- Best for calculating how much you’ll earn over a year
When do you use APR vs APY?
The main difference between how APR and APY are calculated, and therefore used, is the effect of compounding. Simply put, APR is what you pay and APY is what you save. If you take a loan from a bank, this will most likely be priced as APR. Banks and other financial institutions will usually quote interest rates on savings products in APY. The rationale is that APR is better for knowing interest paid per period, so this makes it easy to understand what you owe each month on a home or car loan. Whereas APY makes it easy to calculate interest earned after a year using a specific savings rate, regardless of compounding frequency.
Simply put, APR is what you pay and APY is what you save.
Tools like APRtoAPY.com can help you convert between APR and APY to better understand your financial situation. This can be very helpful for deciding whether it is better to increase savings or pay down debt. We discuss this topic further in our recent article “Should I Save or Pay Down Debt?”
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