Difference Between APR vs APY

The terms APR and APY are significant if you want to borrow or invest money. APR and APY play a vital role in the calculation of interests. Before your next investment, recognize these terms and learn the difference between APR and APY. 

Learning these basics will help you be more mindful while making financial decisions. Here are some tips on how to calculate them and which one amongst these is better in terms of investment. 

What is APR?

APR is an abbreviation for Annual Percentage Rate. The percentage rate determines the amount of interest you will be charged after borrowing money. The APR is directly proportional to the amount of interest you have to pay. If the APR is low, you must pay less interest while borrowing a sum. 
It must be remembered that credit card companies often keep unique APRs for different types of transactions. Before getting involved with a certain company, it is suggested that you investigate their percentage rate and how it may change.
The APR is mainly applied while borrowing money as loans such as through credit cards, personal loans, student loans, home loans, or others. 
APR vs. interest rate can also be differentiated and APR can include other costs like lender fees as well as the interest rate. This makes APR more significant than interest rates when comparing credit offers. Besides evaluating your interest rate for a year, APR includes yearly costs as well, which are added to the loan. It is to be noted that the credit score can alter the annual percentage rate offered to you since it shows your responsible handling of money. If your credit score is higher, you have more chances of getting a lower interest rate. 

To further simplify this concept, APR can be divided into:
    • Fixed APR
Fixed APR is when your loan’s interest rate is unchanging, which makes the APR calculated on the interest rate remain the same. Therefore, the money paid annually does not change as well.
    • Variable APR
Unlike the fixed APR, the APR and the interest rate keep changing here. The change happens based on the market standards.

What is APY?

The Annual Percentage Yield or APY might sound similar to APR, but notable differences exist. APY, also known as EAR or Effective Annual Rate, defines the rate of return you will receive after investing. It is to be noted that this interest is only applicable to principal loans along with lender fees. 
APY is highly dependent on compound interest, the interest earned from your deposited money, which can be earned daily or monthly. However, with daily compound interests, you can earn more money than monthly ones. Because of compounding, you earn interest on the deposited amount and extra interest on the interest you have previously earned. 
APY is helpful when comparing deposit accounts with the same interest rate. The APY will show how daily compounding earns much more interest than annual compounding. It can also help to compare monthly compounding with annual or daily compounding.

Difference between APR and APY

Initially, distinguishing APY from APR might be hard as they both work with interest rates. However, some factors prevent these two concepts from being mirror images. Some of these factors include:
   

• Their Purpose
While APR deals with credit accounts, APY deals with deposit accounts. A lower APR means that your cost of borrowing will also be lower. At the same time, a higher APY means an increased earning on your part.
• They Apply To Different Accounts
As mentioned, APR is exclusively applied to credit accounts and home and car loans. On the other hand, APY focuses on the money put into a savings account, deposit account, or market account.
• Differ In Rates
APR defines the interest applied on the loan, whereas APY is the interest earned annually. This is why having a lower APR rate is better than a higher one, whereas a higher APY rate is better than a lower rate. 

The Major Difference Between APR v/s APY Is Compound Interest

From calculations to application, APR and APY differ in many ways. However, the major difference between APR and APY is their compound interest dealings. 
APR does not deal with compounding. Instead, it only focuses on the interests or lender fees charged on the money you borrow. On the other hand, APY focuses highly on compound interest to deduce the rate of interest to be imbued on your investments or savings. APY avoids the inclusion of additional fees.
APR uses the simple interest method, where the daily interest rate is multiplied by the number of days. Unlike APR, APY makes use of compound interest.
Compounding happens annually as the bank uses the compound interest method to calculate the interest earned according to the APY rate. This becomes important in incrementing your earnings as the bank adds that interest to your earning account. This process continues yearly as the bank keeps calculating the same with your new amount.

APR vs. APY: Which Is Better?

Since they are used for different situations, it is hard to determine which is better. APR is used while taking a loan, home mortgage, or applying for credit cards. A low APR is better in these situations since it means you have to pay much lower interest on borrowed money.
APY is needed while investing in an account that avails interest, like savings accounts, certificates of deposit (CDs), and money market accounts. A high APY is usually better for investment accounts like money market or savings accounts as it entails a higher rate of return on your investment. 

How To Calculate APR and APY

To better understand the Annual Percentage Rate and the Annual Percentage Yield and how they differ, you need to understand how APR and APY are calculated. They are calculated using mathematical formulas stated below. To better grasp the concepts, you should learn what each of these symbols entails.

Here, ‘r’ is the interest rate, and ‘n’ is the number of years.

The table shows that loan amount, fees, and interest are considered when calculating the APR. On the other hand, APY only requires the interest rate to be deduced.

Two factors that must be considered while calculating APR and APY:
    1. To calculate APR, you must collect information about your loan, like the interest rate, change, amount borrowed, how often payments are made, and the loan length.
    2. To calculate APY, you need to know the yearly and periodic rates and how often the interest is compounded annually.

Conclusion

APR and APY are vital in determining interest rates and how they change daily, annually, or monthly. Learning about these in-depth will help investors compare APRs to deduce the best options before investing. While APR deals with interest charges, APY helps to determine the money that can be earned in investments or through savings accounts. Certain factors differentiate these two concepts, including their functionalities, calculations, and how they influence investments. 
Learning about these vitalities is key to making better financial decisions in the future. If you want to invest in crypto or similar entities, measuring the differences between APR and APY and their uses may help in the long run.