When it comes to personal finance, understanding the difference between annual percentage yield (APY) and annual percentage rate (APR) can be crucial. While both terms are related to interest rates, they represent different ways of calculating the cost or earnings associated with borrowing or saving money.
APR is a term commonly used in loans and credit cards. It represents the yearly interest rate that lenders charge borrowers for borrowing money. APR takes into account not only the interest rate but also any additional fees or charges associated with borrowing money.
On the other hand, APY is a term commonly used in savings accounts and investments. It represents the yearly earnings on an investment after taking into account compounding interest. Compounding interest means that you earn interest not only on your original investment but also on any accumulated interest over time.
For example, let’s say you have $1,000 in a savings account with a 1% APY that compounds annually. At the end of one year, you would earn $10 in interest ($1,000 x 0.01). However, if your savings account had a 1% APR instead of an APY and compounded annually as well, you would still earn $10 in interest at the end of one year; however this amount wouldn’t compound over time so your return would remain flat.
It’s important to note that while both terms are expressed as percentages and relate to annual calculations – they apply differently depending on what side of a transaction you are on: Borrowing vs Saving/Investing.
When evaluating financial products like loans or savings accounts – comparing APRs or APYs can give insight into which product is more favorable based off its respective metrics though keep in mind these two values aren’t interchangeable when comparing lending products versus saving ones respectively.
In conclusion:
– APR refers to how much it costs to borrow money.
– APY refers to how much earned from investing/saving money.
– APR takes into account the interest rate and any fees associated with borrowing.
– APY takes into account compounding interest on investments/savings.