What is the difference between APR and APY?
APR stands for Annual Percentage Rate, which is the interest rate that is paid on an investment. APY, which stands for Annual Percentage Yield, also takes into account the frequency with which the interest is applied to the investment. Both affect how much an investor earns or how much a borrower pays on a loan. Most loans and investments use compound interest rate to calculate interest, giving rise to both of these terms.
APR is calculated by multiplying the periodic interest rate with the number of periods in a year in which the periodic rate is applied. It does not indicate how many times the rate is applied to the balance. APY is calculated by adding 1+ the periodic rate as a decimal and multiplying it by itself a number of times equal to the number of periods that the rate is applied, then subtracting 1. APY thus gives you the actual percentage interest that will be accrued over a year.
Both APR and APY are important concepts to understand for managing your personal finances. The more frequently the interest compounds, the greater the difference between APR and APY. When you want to open a new interest-earning account, loan or mortgage, you should carefully compare rates from multiple sources to find the best deal. The lowest advertised rate can actually turn out to be the most expensive. Although there are rules that govern these rates in many countries, many are often abused. Banking institutions can misuse APR and APY to attempt to show potential clients that their rates are better than those of their competitors.