APY vs APR
Posted by mtwinkle on September 1, 2007
APY is the total amount of interest you earn in one year taking into account compound interest. APR is simply the stated interest you earn in one year, without taking compounding into account. Compounded interest is a great feature because it allows you to earn interest on your interest.
For example, if you invest $1,000 in a CD that has 5% annual percentage yield (APY), then you will earn $50 in your first year. As long as you leave that $50 invested in your CD, then you will earn 5% interest on $1050 the following year.
APR = periodic rate * no. of periods in a year
Thus, if a credit card company might charge 1% interest each month; therefore the APR would equal 12% (1% x 12 months = 12%).
APY is compound interest
APY= [(1+ periodic rate)^periods ] – 1
Thus, the APY for 1% interest will be:
[(1+0.01)^12]-1= 12.68% a year
It is in the banks best interest to quote you the APY, as opposed to the APR. They want to quote the highest possible rate they can to entice you with to their bank.
When looking for a mortgage you are likely to choose a lender that offers the lowest rate. Although the quoted rates appear low, you could end up paying more for a loan than you originally anticipated because banks will often quote you the Annual Percentage Rate (APR).
APR < APY