Financial products are becoming more and more nuanced in today’s ever-evolving world, and understanding interest rates is pivotal to having control over your personal or business finances. Within this intricate web, the terms Annual Percentage Rate (APR)—which often surfaces when discussing business loans or personal loans—and Annual Percentage Yield (APY)—which is mostly used when talking about savings—are seemingly synonymous yet fundamentally distinct terms. Understanding the differences between these two concepts can help you make informed financial decisions that will benefit you long -term.
Key Considerations
- APR represents the annual cost of borrowing, shown as a percentage
- Comparing APRs across loans or lenders helps you find the best options.
- APY is similar to APR but refers to money earned in savings or investments, not loan interest.
What Is the Difference between APR and APY?
APR and APY, while both measures of interest, diverge in their application and calculation. APR is the straightforward annual cost of a loan, while APY includes the effects of compounding interest.
Defining an APR
Lenders use several key figures to calculate APRs after a borrower qualifies for a loan, credit card, or mortgage.
The key figures include:
- The principal amount (the initial amount borrowed)
- The interest rate (the cost of borrowing the principal)
- The total time period of the loan
APR reflects the annual cost of the loan, including fees and interest, and is expressed as a percentage.
When you borrow money, you typically have to repay the principal amount plus an additional percentage as interest. The interest rate varies based on the type of loan and your financial situation.
Factors such as the loan term, your credit scores, and other considerations can affect the interest you pay. The APR represents the interest rate for an entire year, including any costs or fees associated with the loan. This gives a more comprehensive picture of the yearly cost of the loan.
Comparing APRs across different loans or lenders can help you find the best option for your needs. For credit cards, where interest is always expressed annually, the terms APR and interest rate are often used interchangeably.
A credit card APR typically does not include additional fees. It's also worth noting that you can avoid paying interest on credit card purchases if you pay off your balance in full each month.
APRs provide a measure of borrowing costs across different financial products, including:
- Mortgages
- Auto loans
- Credit cards
- Personal loans
Defining an APY
Lenders use two key figures to calculate APY, representing the annual rate of return that an investor can expect from interest-bearing accounts.
The key figures include:
- The period or term rate (the interest rate for each compounding period)
- The number of compounding periods (how often interest is compounded per year)
APY reflects the annual rate of return, accounting for the effects of compounding interest, and is expressed as a percentage.
Banks and financial institutions typically display APY as a percentage, which indicates the amount of interest you will earn over the year. According to the Truth in Savings regulations, financial institutions must provide APY information to investors before they open an account. This transparency allows you to compare different investment options and make informed decisions for your investment portfolio.
Unlike simple interest, APY uses compound interest, meaning the financial institution calculates the earned interest annually and adds it to your balance. Generally, a higher APY indicates a better rate of return on your investment. Financial products that typically use APY include:
- Savings accounts
- Certificates of deposit (CDs)
- Money market accounts
- Interest-bearing checking accounts
Learn How BHG Financial's APR Loan Terms Can Benefit Your Financial Situation
BHG Financial provides tailored financing solutions, offering personal loans up to $200,0001. These loans feature flexible repayment terms extending up to 101,2 years. Ideal for personal debt consolidation or home improvements, BHG’s loans come with dedicated, U.S.-based concierge service that's available around your schedule. Begin by obtaining a personalized estimate in just seconds with our payment estimator.
APY vs. APR FAQs
Why is APR important when choosing a loan?
APR provides a clear picture of the total cost of borrowing, including interest and fees, making it essential for comparing loan options.
Can APR and APY apply to the same financial product?
Generally, no. APR is used for loans and credit, while APY is used for savings and investments.
Why is understanding APY important for savers?
It helps you understand how much you will earn over time, taking into account the power of compound interest.
