APY And APR Mean Different Things For Your Interest Rates
In case you didn’t know it, APY and APR aren’t the same thing. You’ve probably seen these three letters on documents you’ve filled out when opening a new bank account, taking out a loan, or applying for a credit card, but do you know what they mean? And what does the difference between the two mean practically to you?
Here’s everything you need to know about these three-letter descriptors, and why they can make a difference when it comes to making financial decisions.
APY stands for annual percentage yield, which pertains to the rate of return an investment or savings deposit will earn during a twelve-month period. Because APY includes compound interest, meaning that interest is earned on the interest itself, it’s regarded as a means of accurately calculating the growth of funds in an investing or savings account.
When advertising or promoting interest-bearing accounts, U.S. banks must include APY in their materials so that customers, or potential customers, can get an accurate assessment of what their funds will earn in a given year. In general, banks compound the interest on savings accounts on a daily or monthly basis; mortgage interest usually is compounded monthly.
APR is short for annual percentage rate, which refers to the annual or yearly rate of interest, but, unlike APY, without any additions from compound interest factored in. If you’re borrowing money, the annual percentage rate indicates what the loan will cost you in interest, as well as other expenses, during one full year.
If you have a credit card, the APR is the interest rate, plain and simple. But with a mortgage, the APR includes the interest along with broker fees, discount points, partial closing costs, and other miscellaneous charges. A savings account could have an APR of 5%, but an APY of 5.09% if the interest on the account is compounded every quarter, or an APY of 5.11% if the compounding is computed monthly.
Why APY And APR Are So Vital
As you probably already know, there are a lot of different loan, savings, and investment products out there. Before you sign on the dotted line for any of them, be certain that you’re comparing APY to APY, or APR to APR, so that you get an accurate picture of what you can expect to pay and to earn. And always take into account the compounding frequency.
If you’re looking to take out a mortgage, the lender, in an effort to make the interest rate sound as low as possible, will most likely inform you of the APR, not the APY. It’s in your best interest to ask what the APY is so that you get a complete a financial picture of the loan you’re considering. On the other hand, a bank looking to entice you to open a savings account will probably tell you about the APY, which will be higher than the APR, and therefore more appealing.
Your understanding of APY and APR doesn’t have to be letter perfect, you just need to remember that the more often interest is compounded, the more you’ll earn — or pay. And keep in mind that it’s always in your best interest to get all of the facts before you make any type of financial decision or commitment.