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Do You Need a Rainy Day Fund If You Already Have an Emergency Fund?APR vs. APY: What’s the Difference?
APR and APY may sound similar. However, these two financial terms are very different. APR measures the amount of interest you’ll pay while borrowing money, whereas APY tracks how much you’ll earn while saving it.
Here’s what you need to know about APR vs. APY and how those differences affect your finances.
What is APR?
Annual percentage rate (APR) is a metric used to help consumers understand the costs associated with borrowing money. It’s often seen when taking out financial products like loans or credit cards.
Thanks to the Truth in Lending Act (TILA), lenders must disclose the APR of any loan or credit offers they send to you. Those APRs can help you make an apples-to-apples comparison between offers from different lenders.
How does APR work?
APR — expressed as a percentage of the loan amount — represents the amount you’ll pay to borrow money each year. It includes interest charges and any fees attached to the loan. For example, the APR for a mortgage loan would likely include the interest rate and any closing costs, such as an origination fee or discount points.
However, APR doesn’t take compounding interest into account. Loans that use compound interest calculate interest on both the principal balance and any interest accrued on the loan.
In contrast, simple interest calculates interest only on the principal amount. As a result, if you take out a loan that charges compounding interest, such as a mortgage, you may pay more in interest charges than the APR advertises — and repaying the loan could take a long time.
How to calculate APR
If you wanted to calculate APR, you would use the following equation:
APR = ((Interest + fees) / loan amount) / number of days in loan term) x 365 x 100
For example, if you borrow a $12,000 personal loan that charges you $1,600 worth of interest and fees and has a one-year repayment term, the math would look like this:
APR = ((1,600) / 12,000) / 365) x 365 x 100
First, divide the total amount of interest and fees ($1,600) by the total loan amount ($12,000) to get 0.1333.
Then, divide that result by the total number of days in the loan term, which is 365 because it's one year. That will give you 0.000365.
Then, multiply that number by 365, resulting in 0.1333.
Finally, multiply your answer by 100, giving you an APR of 13.33% for this personal loan.
APR = 13.33%
What is APY?
Meanwhile, annual percentage yield (APY) is a metric used to help consumers understand how much interest they’ll earn while saving money. It’s often seen advertised with banking products like money market accounts or certificates of deposit (CDs).
The Truth in Savings Act (TISA) requires banks and other financial institutions to publicize this information for all savings products, making it easy to compare the rates you’ll receive.
How does APY work?
Shown as a percentage, APY reflects the amount of interest you’ll earn on the savings account each year. It does not account for any special bonus offers that may be promoted by the bank or financial institution.
Notably, the APY calculation includes compounding interest. When you hold your balances in an account that earns an APY, you can expect to earn interest on your principal balance as well as on any accrued interest.
How to calculate APY
To calculate APY, you need to take into account compounded interest, so the math is a little different. The equation for APY is as follows:
APY = 100 ((1 + interest/deposit amount)(365/ number of days in deposit term) – 1)
Let’s say you took out a $5,000 CD with a 12-month term that pays $150 in interest. In that case, the math would look something like this:
APY = 100 ((1 + 150/5,000)(365/365) - 1)
First, you would divide the total amount of interest ($150) by the total CD ($5,000). This results in 0.03. Then, add 1, giving you 1.03.
Next, divide 365 by the number of days in the CD term, which in this case is also 365, so you get 1.
After that, multiply that first figure by the second (so 1.03 X 1), which comes to 1.03. You then subtract 1, giving you 0.03.
Finally, multiply 0.03 by 100, which gives you 3% as the APY for this hypothetical CD.
APY = 3%
APR vs. APY
It’s easy to see how people can get tripped up when thinking about the differences between APY vs. APR. After all, both these metrics consider an annual rate at which interest accrues. However, beyond that, they are very different.
Here’s a closer look at the key differences between APR vs. APY:
| APR | APY |
| Borrowing metric: It's used to help consumers determine how much interest they’ll pay when borrowing money. | Saving metric: It's used to help consumers determine how much interest they’ll earn when saving money. |
| No compounding interest: An APR calculation doesn’t take compounding interest into account. | Uses compounding interest: The APY calculation takes compound interest into account. |
| Includes fees: The APR calculation also considers any fees borrowers will pay on the loan to calculate their total costs. | Does not include fees: The APY calculation does not take into account any fees that savers pay on the account. |
| May be higher than advertised: Borrowers may pay a higher-than-advertised APR, particularly if they take out a loan product that uses compound interest. | May be lower than advertised: Savers can receive a lower-than-advertised rate if they have to pay fees. |
What is a good APY?
In general, the higher an APY, the more money you will earn over the course of a year. So, if you want to maximize your savings, it’s a good idea to look for the highest APY possible.
However, note that there is no set standard for what constitutes a “good” APY, and the rates will vary over time and between lenders. That’s why it’s a smart idea to do research before opening any type of savings product — it will give you a much better sense of what rates are available to you.
What is a good APR?
As a rule of thumb, the lower the APR, the more affordable it is to borrow that financial product. To that end, it’s a good idea to shop around to find the lowest possible APR when you’re ready to borrow money. This will help you keep more money in your pocket.
However, there is no solid benchmark for what is considered a good APR. The rate you’re offered will often depend on current market rates, as well as the strength of your financial profile. Different lenders can also offer you different rates, which is why comparing APRs on loan or credit card offers could help you save.
Can APR and APY change?
Both APRs and APYs can change under certain circumstances.
Specifically, these metrics are subject to change if the financial product you’re considering comes with a variable rate. For example, money market accounts often have a variable rate APY, and credit cards often have a variable rate APR. Variable rate products can change their rates at any time, and their rates are often closely tied to market rates, such as the federal funds rate.
In contrast, fixed-rate products have interest rates that stay the same for the entire term. Personal loans often have fixed APRs, while CDs generally offer fixed APYs.
In addition, an APY can change in another instance: Some banks and financial institutions may institute balance tiers, allowing you to earn more as you save more. APRs don’t share this feature.