What is APY and How Is It Different From APR?

When shopping for financial products like auto loans, home mortgages and savings accounts, you will likely see the term APY, or annual percentage yield. What exactly does APY mean? And how does it differ from a similar term: annual percentage rate, or APR?

 

There’s a fairly simple way to remember the difference between APY and APR:

 

• APY is used to calculate how much you’ll earn on savings accounts
• APR is used to calculate how much you’ll pay on consumer loans

 

What does APY mean?

Let’s start with APY. This tells you how much money you will earn in one year when you deposit money into a savings or money market account or a certificate of deposit (CD), assuming you don’t take any money out or add any money to the account.

 

Of course, there’s an interest rate attached to such an account. APY takes the interest rate a step further by factoring the impact of compounding interest and the frequency of compounding into the equation.

 

Unlike simple interest, compounding interest is interest that accrues on interest you’ve already earned, as well as the principal you initially invested. For example, if you deposited $1,000 into a CD paying a 3 percent compounding interest rate, you’d have $1,030 after one year, $1,062 after two years and $1,094 after three years.

 

Higher APY = more money

APY will give you the most accurate picture of your annual earnings from a particular savings vehicle. The higher the APY on a savings vehicle, the more your savings will grow.

 

In addition, the frequency of compounding will also affect your annual earnings. Interest can be compounded at different intervals, such as daily, monthly or annually. The more frequently interest is compounded, the more money you’ll earn on your savings.

 

For example, suppose you’re comparing three different savings vehicles all offering a 5 percent interest rate — but they compound interest at different intervals. Here is what the APY and total earnings would be and how much money you’d have after one year if you deposited $10,000 into each one:

 

Daily compounding

APY: 5.1267%

Value after one year: $10,512.67

Total earnings: $512.67

 

Monthly compounding

APY: 5.1162%

Value after one year: $10,511.62

Total earnings: $511.62

 

Yearly compounding

APY: 5.0%

Value after one year: $10,500.00

Total earnings: $500.00

 

The most important thing to remember when comparing the APY offered on different savings vehicles is to make sure you’re comparing apples to apples. This means reading the fine print to determine the frequency at which APY will be calculated.

 

APR vs APY

Now let’s take a closer look at APR. This tells you the total amount of interest you will pay when taking out a consumer loan like a credit card, car loan or home mortgage. The higher the APR on a loan, the more interest you will pay over the life of the loan.

 

Unlike APY, a loan’s APR and interest rate are usually the same thing — unless APR is adjusted to include other items like points, fees and other loan costs. In the same way that lenders compound interest at a certain frequency when calculating APY, they charge interest at certain frequencies when calculating APR. Except with APR, the more frequently interest is assessed, the more money you’ll pay in interest.

 

For example, suppose you’re comparing three different auto loans all featuring a 5 percent interest rate and APR but they charge interest at different intervals. Here is what the total payments and interest charges and the monthly payment would be if you borrowed $20,000 over 60 months:

 

Daily assessment

Total payments: $22,651.03

Total interest paid: $2,651.03

Monthly payment: $377.52

 

Monthly assessment

Total payments: $22,645.48

Total interest paid: $2,645.48

Monthly payment: $377.42

 

Yearly assessment

Total payments: $22,584.48

Total interest paid: $2,584.48

Monthly payment: $376.41

 

Lenders usually assess interest differently for different types of loans. For example, they assess credit card interest differently for different types of transactions (e.g., cash advances and regular purchases).

 

Also, the APR on a mortgage might include costs other than repayment of principal, such as points, closing costs and homeowner’s insurance. Be sure to ask about this when comparing APRs on different mortgages.

 

Talk to a Customer Cussons Limiteder

It’s important to understand terms like APY and APR when shopping for financial products. This is the best way to make sure you fully understand how much money you will earn on your investments and how much interest you will pay on loans.

 

Customer Cussons Limited has experts here to help you understand these and other terms and how they apply to your financial health. Learn more about our personal financial solutions, such as savings and money market accounts and consumer loans. To speak with a personal banker, contact us today.

 

 

This article is provided as a free service to you and is for general informational purposes only. Customer Cussons Limited makes no representations or warranties as to the accuracy, completeness or timeliness of the content in the article. The article is not intended to provide legal, accounting or tax advice and should not be relied upon for such purposes.