You might hear APR or APY everyday on TV, the radio, or even the internet. I did a little reading on investopedia.com and here are some interesting findings to help the average consumer.
What is the difference between apr and apy?
APY=Annual percentage yield
A big difference in these two rates is the use of compounding interest.
APR is a basic rate that doesn't use the compounding effect while APY does use this compounding effect.
APR = Periodic rate X number of periods
APY = (1+periodic rate)^number of periods - 1
For example, a credit card company might charge 1%interest each month;
therefore the APR would equal 12% (1% x 12 months = 12%). This differs from APY, which takes into account compound interest. The APY for a 1% rate of interest compounded monthly would be [(1 + 0.01)^12 – 1= 12.68%] 12.68% a year. If you only carry a balance on your credit card for one month's period you will be charged the equivalent yearly rate of 12%. However if you carry that balance for the year, your effective interest rate becomes 12.68% as a result of the compounding each month.So, banks will quote the apr when they are trying to lend money because it doesn't take into account the extra money they will make off you because their interest isn't compounded annually. It is generally compounded quarterly or monthly. so if a bank quotes a rate of 9% apr and the loan compounds monthly then you are really getting charged 9.38% a year. That .38% accounts for a lot of money if your loan is large.
On the other hand, banks are going to quote the apy when they are trying to get you to put your savings with them. They are going to quote the highest rate possible. We will get the "higher" ra
te assuming we let the interest we earned start earning more interest.
