APR vs APY
APR vs APY
While APR is a more accurate estimation of the total cost of a loan than the nominal interest rate, it is limited because it only considers a simple interest rate. If the interest compounds on a smaller time frame than annually (such as monthly or semi-annually), the actual interest paid will be higher than the APR advertised. Factoring in compounding interest that happens within a year gives you a loan’s APY, or Annual Percentage Yield (sometimes also called EAR, or Effective Annual Rate).
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When Is APR vs APY Used?
As a helpful rule of thumb, most credit card companies use an APR compounded monthly, whereas most mortgages use an APR that is calculated on an annual basis and is therefore the same as APY. If you are carrying credit card debt, your APR is already high to begin with, but your APY is even greater than the stated APR, plus you may be charged additional fees for late payments!
Here is how to remember interest rate, APR, and APY:
- Interest rate is the interest on the principal borrowed which does not factor in additional fees, and is usually stated annually.
- Annual Percentage Rate (APR) is the interest plus additional fees, stated as a percentage. This is stated annually and therefore does not factor in rates compounded on smaller time frames (such as monthly).
- Annual Percentage Yield (APY) or Effective Annual Rate (EAR) factors in additional fees and whether the rate is compounded on a smaller time frame. An APR is needed to compute the EAR.
Compounding interest monthly rather than annually and other maneuvers like these to further enslave those in credit card debt is why credit card companies and other consumer lenders have a poor reputation.
Now that you know the difference between the nominal interest rate, annual percentage rate, and effective annual rate, consider sharing this information with a friend to help them with their financial situation.
APR vs APY FAQs
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True contributes to his own finance dictionary, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.