Both APR (annual percentage rate) and APY (annual percentage yield) are two very different terms used in interest calculations. It is always better to know in advance the difference between APR and APY, if you are thinking of borrowing or opening saving account in bank.
What Is Annual Percentage Rate (APR)?
APR, or Annual Percentage Rate, indicates how much interest you will get on an annual basis without taking into account the effects of compounding. This method considers the nominal interest rate, the period or time (in years) and the original balance. For example, you have a Rs 5,000 balance with a 5% APR. In one year, your account would accumulate Rs 5,000 x 5% = Rs 250. Add to this amount your original balance of Rs 5,000 and you will get total of Rs 5,250.
APR = Periodic rate x number of periods in a year
What Is Annual Percentage Yield (APY)?
APY, or Annual Percentage Yield, is the same measure of interest rate, but it takes into account that your balance will change after each time interest is paid out. APY is a better indicator of how much you will actually pay (or receive) in interest. For example, you have a Rs 5,000 balance with a 5% APR. The interest is applied to the balance on a monthly basis. It means that the 5% APR will be divided into 12 smaller interest payments for each month. In this situation your monthly interest rate will be 0.42%. Your original balance will earn Rs 21 in interest after the first month. In the next month, 0.42% will be applied to the new principal of Rs 5,021, and so on. As you see, although your APR is 5%, the total amount of interest you will earn for the year will be around Rs 256. It means that the APY is close to 5.12%. As a rule, APY is always higher than APR.
APY = (1+Periodic rate) to the power of (number of periods – 1)
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The example below is of a one-time deposit of Rs 5,000 with an interest rate of 4%. The APY & APR below is compounded yearly.
|5 Years||Rs 6083.26||Rs 6000|
|10 Years||Rs 7401.22||Rs 7000|
|15 Years||Rs 9004.72||Rs 8000|
|20 Years||Rs 10955.62||Rs 9000|
|25 Years||Rs 13329.18||Rs 10000|
Since the APR is lower than the APY, smart lenders always use APR to make their loans look less expensive. In contrast, smart banks will always use APY to make their interest rates look more attractive to depositors. As a result, APR is generally used to describe the rate paid to a lending institution by a borrower, while APY generally used to refer to the rate paid to a depositor by a lending institution.
Difference Between APR And AYP
- APR is the annual percentage rate that applies for your deposit or loan while APY is the total interest earned during the year.
- APR does not consider the compounding interest (interest on the interest) into account while APY does.
- APR is generally used to describe the rate paid to a lending institution by a borrower, while APY generally used to refer to the rate paid to a depositor by a lending institution.
Always Compare APY to APY
When shopping for a new savings account, CD, or money market, make sure that you are comparing APY to APY. That means if you are comparing one account advertising its APR with another’s APY, the numbers may not reflect which account is better. When comparing the APY of both, you have a clear picture that shows which account will yield more interest.