What is the difference between APR and APY?

APR (Annual Percentage Rate) and APY (Annual Percentage Yield) are two different ways of expressing interest rates and are commonly used in the context of financial products such as loans, credit cards, and savings accounts. While they sound similar, they represent different aspects of interest calculation.

Related Article: Understanding the Differences Between Saving & Investing

APR (Annual Percentage Rate)

APR represents the annualized cost of borrowing or the interest rate charged on a loan or credit card. It does not take into account compounding, which means it only considers the simple interest rate over a year. In other words, it assumes that the interest is not reinvested or compounded throughout the year.

For example, if you have a credit card with an APR of 18%, and you carry a balance of $1,000 for a year, the interest you would pay would be 18% of $1,000, which is $180.

APY (Annual Percentage Yield)

APY, on the other hand, accounts for compounding, making it a more accurate representation of the actual yield or return on an investment or a savings account. APY takes into consideration that the interest earned is reinvested or added back to the principal, and thus, the interest is compounded over time.

For example, if you have a savings account with an APY of 2%, and you deposit $1,000, the interest you earn at the end of the year will not just be 2% of $1,000 ($20), but it will also include the interest earned on the interest previously credited to your account.

In general, the APY is always higher than or equal to the APR, as it accounts for compounding. When comparing financial products, especially savings accounts or investments, it's essential to consider the APY as it gives a more accurate representation of the potential earnings over time.

To sum up, APR is used for loans and credit cards, while APY is used for savings accounts and investments. APR does not include compounding, whereas APY does include the effects of compounding.