The difference between APY and APR
APY and APR are two acronyms that refer to compound interest. Albert Einstein once said that compound interest is the greatest force on the planet. It has a tremendous impact on our lives, especially on our finances. APY stands for “annual percentage yield” and APR stands for “annual percentage rate”. Everyone who deals with banks has heard the terms, but not many people understand the difference between them. These two terms deal with making our money work for us when we have money to deposit and the stress we have to go through in repaying loans or credit card balances.
Compound interest is interest charged on the previous interest. If you deposit $1000 into your bank account and it earns interest at the end of the month, this increases the total that you have in your bank account. The following month the interest is paid on the deposit plus the interest you earned. At the end of the year you get more money than you would if the interest was only paid once a year.
In the case of borrowing money, compound interest works against you. This is especially true of credit card balances. The company may state that its APR is 19%, but when the calculation is done monthly, the interest charged on your balance is actually greater than 19%. You could say that the APR is the stated rate of interest and APY is the effective rate of interest. This is why it is important that you understand the difference between the two because credit card and financial institutions do advertise a low APR in an effort to get you to borrow.
You do have to be aware of the policy by which the bank, credit card company or lending institution calculates the interest that is charged on your outstanding balance. You will always receive an APR quote, but no one will ever try to explain the effective rate of interest. This is why you should be a wise consumer and have an understanding of the ways in which APY and APR differ from each other.
When you go to the bank to apply for a loan, the person you deal with will tell you the rate of interest that you will be charged. This is the APR. However, when you actually do the calculations of the way interest is compounded, you will pay more than this rate. Therefore APY refers to the effective rate of interest.