You may have encountered the terms APR and APY when researching loans or savings accounts. APR and APY are ways of calculating interest, but they differ in how that interest is calculated. Understanding the difference between APR and APY is important to make informed decisions about your finances.
How Is Interest Calculated?
To understand the difference between APR and APY, it’s first necessary to understand how interest is calculated. When you take out a loan, the lender will charge you interest. This is expressed as a percentage of the total loan amount. For example, if you take out a $100 loan with an interest rate of 10%, you will owe $110 when the loan is due. The extra $10 is the interest that you have to pay.
However, interest is not simply calculated on the original loan amount. It’s also calculated on any previous interest accrued but not yet paid. This is what’s known as compound interest. To continue with our example, let’s say that you only make minimum monthly payments on your loan, and it takes you two years to pay it off. At the end of those two years, you will have paid a total of $120 in interest – even though the original interest rate was only 10%.
This is because your interest payments are compounded every month. In other words, each month, you’re not only paying interest on the original loan amount but also on any previously accrued interest. Over time, this can add up to a significant amount of money.
What Is APR?
Now that we’ve explained how interest is calculated, let’s take a closer look at APR. As we mentioned before, APR stands for Annual Percentage Rate. This is the yearly interest rate charged on a loan or investment.
To calculate APR, divide the total amount of interest paid by the original loan amount and multiply by 100 to get a percentage value. In our example above, if you took out a $100 loan with an annual interest rate of 10%, your APR would be 10%. However, if it took you two years to pay off the loan (as in our compound interest example), your APR would be 20% ($120 in total interest paid / $100 original loan amount x 100 = 20%).
What Is APY?
APY stands for Annual Percentage Yield and refers to the Total Interest Paid on investment over one year as a percentage of your original investment amount – including compounding interest. To calculate APY, divide your total investment earnings (including compound interest) by your original investment amount and multiply by 100 to get a percentage value.. For example, if you invested $100 at 10% APY over one year, you would have earned $10 in compound interest($100 x 0.1 =$10). Therefore – your total return would be$110($100 +$10=$110)andyourAPY wouldbe10%($110/$100x 100=10%).
The Difference Between APR and APY
Now that we’ve explained how APR and APY are calculated, let’s take a look at the key differences between them:
– APR is the yearly interest rate charged on a loan or investment.
– APY is the Total Interest Paid on investment over one year as a percentage of your original investment amount – including compounding interest.
– APR does not take compounding interest into account. APY does.
– For loans, APR will always be higher than the stated interest rate unless the loan is paid off early. For investments, APY will always be lower than the stated interest rate unless you withdraw your money early.
Ways to Make Informed Decisions About APR and APY
Whether you’re taking out a loan or investing your money, it’s important to understand the difference between APR and APY. This will help you make informed decisions about your finances.
When comparing loans, be sure to look at the APR rather than the interest rate. This will give you a more accurate picture of how much the loan will cost you in interest.
When comparing investment options, look at the APY rather than the interest rate. This will give you a more accurate picture of how much your investment will earn in interest over time.
Remember, compound interest can significantly impact the total cost of a loan or the total return on investment. Be sure to factor this in when making financial decisions.
Conclusion
It’s important to know the difference between APR and APY when you’re looking to take out a loan or make an investment. APR is the interest rate charged on a loan or credit card over a year, while APY is the yield you earn on investment over a year. Both rates can affect you in different ways, so it’s important to make informed decisions about both before making a final decision.
FAQ
How do I know what APR I have?
The best way to determine your APR is to ask your lender. You can also find your APR by looking at your monthly statement if you have a credit card. Your APR will be listed as a percentage rate and usually followed by the words “interest rate.” For example, if your APR is 18%, that means that you’ll be charged 18% interest on any outstanding balances on your loan or credit card each year.
What is APY in Staking?
When you stake cryptocurrency, you’re essentially putting your money into an account and agreeing to leave it there for a certain period of time. In return for keeping your money locked up, you’ll earn interest on your investment. The interest rate you earn is an APY or annual percentage yield. For example, if you stake $1,000 worth of cryptocurrency and earn an APY of 5%, that means you’ll have earned $50 in interest at the end of the year.
