After being indulged in investments, savings, loans, and credit cards, there are two important terms that you should not stay aloof with. And these are APR(annual percentage rate) and APY(annual percentage yield); both terms may sound the same. But the meaning and productivity of both APR and APY are different. Where APR is generally used to determine the cost of borrowing such as a loan or credit card. On the other hand, APY is used to calculate the amount you have earned when saving or investing money. Hence, to make better financial decisions, figuring out and learning about APR and APY help make your financial decisions better. And to ease your investment, credit cards, savings, browning & loan repayment journey.
What Is APR?
As we discussed earlier, APR is the annual percentage rate of a loan or credit card. You can also consider it as the total annual cost of borrowing money, such as fees in the form of a percentage.
APR is usually expressed in the form of a percentage to compare the cost of credit easily. You can either find an APR fixed or a variable. When it comes to a fixed APR, it remains the same till the end of the loan without making any changes.
On the other hand, a variable APR denotes the interest rate tied to an underlying index. And these can be the federal prime rate and the fluctuating rate that majorly depends on market conditions over time. For instance, you may have seen that most credit cards have variable APRs.
If you are a loan applicant, then APR basically includes the interest rate or standard fees. Plus, other financial charges as a minor part of your loan agreement. Suppose you applied for a $10,000 loan with an interest rate of 10%, a 1% origination fee, and a 5-year loan term. Then your collective APR will be around 10.43%.
Apart from loans, the APR and the interest rate will be taken as the same on credit cards. The fact is the payments of additional fees such as foreign transaction fees, annual fees, and balance transfer fees are supposed to be excluded from the APR calculation.
Another thing to consider is that credit cards have several APRs that apply differently to transactions or account activities. The basic formula to calculate APR is APR = ((Fees + Interest/Principal)/n) x 365 x 100; here, n represents the number of days in the loan term.
The following points to calculate APR are:
- First, calculate the interest you must pay over the entire loan tenure.
- Next, you need to add the fees.
- Now continue by dividing the sum by the principal amount or loan amount.
- Here, you need to divide the outcome by the total number of days of your loan repayment tenure.
- Further, you need to multiply the outcomes of the last one by 365.
- In the previous step, multiply the outcome by 100 to convert it into a percentage.
What Is APY?
As per the earlier information, the term APY stands for the annual percentage yield, which is an outcome of the total amount of interest. The APY interest denotes the interest you can earn only with an interest-bearing account. Remember, your interest amount depends upon the one-year interest rate and frequency of compounding.
Usually, the APY is calculated in the form of a percentage, so you can easily compare interest-driven financial products. And these can be savings accounts, checking accounts, deposit certificates, etc. Moreover, we can find APY slightly higher on a deposit account as compared to the interest rate from the perspective of compound interest.
As we know, compounding is required where the interest accrues (daily, weekly, monthly, quarterly, or annually depending on the account) on both the principal amount and the interest accumulated in previous compounding periods. The basic formula to calculate APY is: APY = (1 + r/n)n – 1.
Follow the below point to calculate APY:
- Firstly, you need to convert the interest rate into decimal form. For instance, the 1% interest rate decimal would be 0.01.
- Next, you need to divide the interest rate by the number of each year of compounding periods.
- Now, you must add the outcome of the previous last point and 1.
- Further, take the total to the power of the number of each year of compounding periods.
- In the previous step, subtract 1 from the outcome.
Compounding Differences Between APY and APR
Primarily, APY considers compound interest, but on the other hand, the APR does not. APY calculates your return, or earnings, on an annual basis in the form of a percentage. But if you see APRs, it generally doesn’t consider compounding interest. Moreover, while not paying off your credit card dues every month, interest will be charged as the unpaid balance. Consequently, the interest will start to arise on any new purchases from the transaction date until your balance is paid in full. As per the APY, any accruing interest is compounded daily, but nothing such implies in the case of credit card APRs.
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