When you borrow money or make an investment, you know the interest rate is important. But as you compare rates on financial products, you may find that they’re expressed in two different ways: annual percentage rate (APR) and annual percentage yield (APY).
While these two abbreviations may only be one letter apart, there are big differences between them. Here’s what you need to know about these two terms, as well as why it’s so important to understand APR versus APY.
The differences between APR and APY
While both APR and APY are used to describe the interest rate paid on an investment or charged on a loan, there is one key difference between the two. APR is your yearly rate without taking compound interest into account. APY, on the hand, is your effective annual rate and includes how often interest is applied to your balance.
The interest on your investments may compound daily, monthly, quarterly, or yearly, and interest earned is added to the principal balance. When interest is added to the balance, it’s called compounding. And when interest is paid on interest, it’s called compound interest.
Many credit card providers compound interest daily. That means your balance at the end of each day is multiplied by the daily interest rate to calculate the interest you owe. This is compounded, or added to the amount you owe. The next day, you’re charged interest on a slightly higher balance.
APY takes this compound interest into account to show you how much you may pay or earn. Since loans and investments may compound interest more often than once a year, APY is typically higher than APR. But if a loan compounds once annually, APR and APY could be the same.
APR vs. APY: Compounding makes a big difference
To better understand the difference between APY and APR, consider a real-world example.
Say you wanted to invest $10,000 in a certificate of deposit, and you have the option to invest in one of two accounts. Each one earns 2.00% APR but one compounds monthly while the other compounds annually. Here’s how your money would grow over the course of a year.
|Investment||APR||Compounds||Interest earned||Balance after a year|
The account that compounds monthly earns more interest. Your balance grows faster because the interest you earn is being added to the principal every month. If your interest compounds annually, you’ll sit on the same balance for most of the year before you earn interest.
The more often interest compounds or is added to your balance, the bigger the difference between APR and APY.
How to calculate APR vs. APY
When an investment is being marketed, it’s often in APY. That’s because APY makes the amount of interest you earn look higher.
But when you borrow money, the lender typically expresses the interest you’re charged in APR. That’s because the APR makes it seem as though you’re not being charged as much interest.
If a loan or investment lists an annual interest rate, you can convert it to APY to see how much interest you’d actually earn or pay. Some online calculators can make this process easy. But you can do the math using this formula:
APY = 100[(1 + r/c)c – 1]
In the above formula, “r” is your annual interest rate represented as a decimal. “C” stands for the number of times interest compounds on your account.
Let’s assume that you have a 6.00% annual rate (0.06) and that interest compounds monthly (12 times a year) on your account. The formula would look like this:
APY = 100[(1 + 0.06/12)12 – 1
Using the above formula and rounding up to the hundredth place, your APY would be 6.17%.
Make sure you compare the same rates
When you’re looking to borrow or invest, it’s important that you compare apples to apples. There are big differences between APR versus APY. That can make it difficult to compare loan and investment products if their rates are expressed in different ways.
But now you know how to convert from APR to APY. That may help you make informed choices about your investments and the loans you take out.
Interested in a personal loan?Here are the top personal loan lenders of 2018!
|Lender||APR Range||Loan Amount|
|1 Includes AutoPay discount. Important Disclosures for SoFi.
2 Includes AutoPay discount. Important Disclosures for Payoff.
3 Important Disclosures for FreedomPlus.
4 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
5 Important Disclosures for LendingPoint.
6 Important Disclosures for LendingClub.
All loans made by WebBank, Member FDIC. Your actual rate depends upon credit score, loan amount, loan term, and credit usage & history. The APR ranges from 6.16% to 35.89%. For example, you could receive a loan of $6,000 with an interest rate of 7.99% and a 5.00% origination fee of $300 for an APR of 11.51%. In this example, you will receive $5,700 and will make 36 monthly payments of $187.99. The total amount repayable will be $6,767.64. Your APR will be determined based on your credit at time of application. The origination fee ranges from 1% to 6% and the average origination fee is 5.49% as of Q1 2017. There is no down payment and there is never a prepayment penalty. Closing of your loan is contingent upon your agreement of all the required agreements and disclosures on the www.lendingclub.com website. All loans via LendingClub have a minimum repayment term of 36 months or longer.
7 Important Disclosures for Earnest.
8 Important Disclosures for Avant.
* The actual rate and loan amount that a customer qualifies for may vary based on credit determination and other factors. Funds are generally deposited via ACH for delivery next business day if approved by 4:30pm CT Monday-Friday. Avant branded credit products are issued by WebBank, member FDIC.
** Example: A $5,700 loan with an administration fee of 4.75% and an amount financed of $5,429.25, repayable in 36 monthly installments, would have an APR of 29.95% and monthly payments of $230.33
* Important Disclosures for Upgrade Bank.
Upgrade Bank Disclosures
** Accept your loan offer and your funds will be sent to your bank via ACH within one (1) business day of clearing necessary verifications. Availability of the funds is dependent on how quickly your bank processes this transaction. From the time of approval, funds should be available within four (4) business days.
|7.73% – 29.99%||$1,000 - $50,000||Visit Upstart|
|6.26% – 14.87%1||$5,000 - $100,000||Visit SoFi|
|6.99% – 35.97%*||$1,000 - $50,000||Visit Upgrade|
|8.00% – 25.00%2||$5,000 - $35,000||Visit Payoff|
|4.99% – 29.99%3||$10,000 - $35,000||Visit FreedomPlus|
|5.99% – 18.99%4||$5,000 - $50,000||Visit Citizens|
|15.49% – 34.49%5||$2,000 - $25,000||Visit LendingPoint|
|6.16% – 35.89%6||$1,000 - $40,000||Visit LendingClub|
|6.99% – 18.24%7||$5,000 - $75,000||Visit Earnest|
|9.95% – 35.99%8||$2,000 - $35,000||Visit Avant|