APY (Annual Percentage Yield) and APR (Annual Percentage Rate) are both measures of interest, but they are used in different contexts and calculated differently.
APY and APR differences
- APY (Annual Percentage Yield):
- Definition: APY represents the real rate of return earned on an investment, taking into account the effect of compounding interest.
- Use Case: Often used for savings accounts, CDs, and other investments where interest compounds over time.
- Calculation: APY considers the frequency of compounding (daily, monthly, etc.). The formula is: APY=(1+rn)n−1APY = \left(1 + \frac{r}{n}\right)^n – 1APY=(1+nr)n−1 where rrr is the annual interest rate, and nnn is the number of compounding periods per year.
- APR (Annual Percentage Rate):
- Definition: APR is the yearly interest rate charged on borrowed money, without considering the effect of compounding.
- Use Case: Commonly used for loans, credit cards, and mortgages to indicate the cost of borrowing.
- Calculation: APR includes any fees or additional costs associated with the transaction but does not account for the effect of compounding within the year. The formula is generally simpler: APR=Interest Paid in a Year+FeesPrincipal Amount×100APR = \frac{\text{Interest Paid in a Year} + \text{Fees}}{\text{Principal Amount}} \times 100APR=Principal AmountInterest Paid in a Year+Fees×100
Key Differences:
- Compounding: APY accounts for interest compounding, making it a more accurate reflection of the true return on investment. APR does not consider compounding, providing a straightforward measure of borrowing cost.
- Application: APY is typically used for deposits and investments, while APR is used for loans and credit cards.
- Impact of Fees: APR often includes additional fees or costs beyond the interest rate, while APY focuses solely on the interest earned.
Understanding these differences is crucial for making informed financial decisions, whether comparing savings options or evaluating loan terms.
