APR Vs. APY: What You Need To Know

Whether you are borrowing or saving money, interest rates can have a big impact on your finances. As you get familiar with interest rates, you’ll come across both APY and APR. While these sound similar, it’s critical to understand the difference.

What Is APY Vs. APR?

Both APY and APR deal with interest rates. However, one represents the amount of interest you’ll pay on a loan, while the other represents how much interest you can earn on your savings.

APR

APR stands for annual percentage rate. It’s a term that describes what a borrower will pay to a lender for the opportunity to borrow money. In addition to interest, APR includes any extra costs or fees associated with the loan.

The percentage represents the annual cost over the term of your loan. Importantly, APR doesn’t include compounding interest.

Some of the products that may involve an APR include:

• Mortgage
• Personal loans
• Credit cards
• Auto loans
• Student loans

Since APR includes all of the costs of borrowing, you can use the number to compare different lenders more evenly.

APY

APY stands for annual percentage yield. This term describes the amount of interest earned on an annual basis. Unlike APR, APY does take compound interest into consideration.

Some of the products that may involve APY include:

• Savings accounts
• Checking accounts
• Certificates of deposit
• IRAs
• Money market accounts

For example, if you’re trying to compare what you’d get with a money market account versus a savings account, you can look at APYs to determine how attractive a particular account type is.

Difference Between APR And APY

The key difference between APR and APY is whether you will earn interest or pay interest. In general, APYs offer savers and investors a glimpse at how much they can earn by parking their funds in a particular account. With that, savers and investors tend to pursue higher APYs.

In contrast, APRs are often used to show prospective borrowers how much the loan will cost. Since a higher APR indicates higher costs, borrowers tend to seek out lower APRs.

Another key distinction is that APY takes compounding interest into account. Compound interest involves earning interest payments on the interest you’ve already earned. APR doesn’t take compound interest into account. Instead, APR only calculates simple interest.

APR Example

While you can use an online calculator to see how much you’ll pay based on a particular APR, it’s helpful to understand the math behind it.

First, here’s the formula for APR:

APR = ([Fees & interest paid over lifetime of loan ÷ Principal loan amount] ÷ Number of days in your loan term) × 365 × 100

As an example, let’s say you take out a personal loan for $10,000. You are paying an 11% interest rate and a $500 closing fee. The loan term is for 5 years and interest compounds annually. With that, your real APR is 13.15%.

APY Example

If you want to run the numbers for an APY, you can use an online calculator or put pen to paper. Here’s the formula to use:

APY = (1 + (Interest rate ÷ n))n - 1

Keep in mind that “n” equals the number of compounding periods, which is either 12 months or 365 days.

Let’s say you open a savings account with $5,000 and an interest rate of 3%. If interest compounds daily, and you leave your money in the account for one year, your effective APY is 3.05% APY.

How To Shop For The Best APR

If you are in the market for any kind of loan product, like a mortgage or credit card, finding the best APR can make a big difference to the total cost of your loan. Follow the steps below to find the best APR:

• Compare apples to apples. As you look for a loan product, make sure to look at the APRs attached. If you compare APRs against interest rates, you might not accurately determine the most affordable lending option.
• Check your credit score. Lenders tend to offer borrowers with high credit scores the best rates. If your credit score is less than ideal, there are things you can do to try to improve it. For example, making on-time payments could improve your score.
• Get quotes from multiple lenders. Even if you already work with a particular lender, take time to get quotes from several lenders. Shopping around can help you find the best rate for your situation.

As you look for the best APR, seek out the lowest possible rate. After all, you don’t want to overpay for borrowing money.

How To Shop For The Best APY

On the other side of the coin, savers and investors looking for the best APY should seek out the highest APYs possible. A higher APY can help you grow your funds faster. Below are some ways to help you find the best APY:

• Shop around. In order to find the best APY, you’ll need to shop around to find the highest one on the market.
• Consider variable versus fixed rates. Some deposit products, like certificates of deposit, give savers a locked-in APY for a set amount of time. But others have variable APYs, which could change at any time. Choose the APY that makes sense for your financial goals.
• Periodically reassess your finances. It’s not uncommon for a bank to drop the APY on a popular savings account at some point. Take time to reevaluate your APY opportunities at least once a year to make sure your funds are getting the most bang for your buck.

FAQs

Here are some answers to the most commonly asked questions regarding annual percentage rates and annual percentage yields.

Can you compare APR to APY?

APR and APY are used for different purposes. If you want to grow your funds, then looking for a deposit or investment account that offers a high APY is ideal. But if you are shopping for a loan, it’s best to look for lower APRs.

Is an APY of 3% good?

It’s impossible to decide if a 3% APY is good or bad without looking at rates from similar products. For example, if you are shopping for a high-yield savings account and find some offering 5% APY, then 3% is subpar. But if you only see other APYs under 1%, then 3% is a good option.

What does 5% APY mean?

An APY of 5% means that your investment or savings account balance will grow by 5% over the course of a year.

The Bottom Line

Both APRs and APYs play a big role in your finances, which makes it important to understand the details. Taking a closer look at the fine print could help you save thousands of dollars in interest charges over a long-term loan, like a home loan. 

If you are looking to move forward with a home loan, start the approval process today with Rocket Mortgage^®.