APR vs. APY: What to Aim For! Get ready to celebrate when one is low and the other is high!

Key Takeaways

• The Annual Percentage Rate (APR) is your go-to figure for understanding the total annual cost of borrowing money!

• The Annual Percentage Yield (APY) is the exciting number that shows you how much interest you'll earn annually on savings accounts and certain investments!

• Score big savings with a lower APR on loans and credit lines and boost your earnings with a higher APY when saving!

APR and APY might seem similar since they both deal with interest on financial products like loans, credit cards, and bank accounts, but don’t be fooled—they’re different! One should be low, and the other should be high. Dive into the details of APR vs. APY and discover why they’re crucial for your financial success!

What is APR?

APR, or annual percentage rate, is the interest rate you pay to borrow money, plus any loan fees that may apply, like closing costs on a mortgage or auto dealer charges on a car loan. A product’s interest rate tends to be lower than its APR, since the interest rate doesn’t include fees. A low APR means you’ll spend less to borrow money, and a high APR means you’ll spend more.

What is APY?

APY, or annual percentage yield, is the annual interest rate you earn on accounts that pay interest, like savings accounts, and certain investments, like certificates of deposit (CDs). The higher the APY, the more interest you earn; the lower the APY, the less interest you earn. For example, if you have a savings account with a $10,000 balance and a 3.75% APY, you’d earn $375 in interest over the course of a year (assuming interest compounds yearly). If the APY were 4.25% instead, you’d earn $425 in interest on that $10,000 by the end of the year.

APR vs. APY: Similarities and differences

APR and APY tell you about interest in 2 distinct ways. Let’s take a closer look at how they’re alike and different.

They apply to different products

APRs apply to lending products like:

• Mortgages

• Personal loans

• Student loans

• Auto loans

• Credit cards

• Home equity lines of credit (HELOCs)

APYs apply to banking and investment products like:

• Savings accounts

• Checking accounts

• CDs

• Money market accounts

• Cash management accounts

You want a low APR and a high APY

When shopping for a loan, you’ll ideally want the lowest possible APR. A lower APR means paying less in total interest and fees. But when it comes to interest-earning accounts like savings accounts and CDs, the highest possible APY will earn you the most interest on your cash.

Both APRs and APYs can fluctuate

Unless your rate is fixed, both APRs and APYs can be variable, meaning they could change while you hold the loan or the account. Both are indirectly linked to the federal funds rate, which is set by the Federal Reserve. When the Fed increases or decreases that rate, many APRs and APYs could follow suit.

Interest on both can compound

Compound interest is when you are charged or paid interest on not just the amount you’ve borrowed or deposited but also on interest that’s already accrued. This can either work for you or against you. If you’re borrowing money, compound interest can significantly increase your total costs, especially with credit cards if you carry a balance from month to month. With a savings or investment account, though, compound interest can help your money grow at a faster pace.

Only APRs account for fees

While it’s a common misconception, the main difference between APR and APY isn’t about compounding interest—it’s about fees. Both APR and APY actually do account for how frequently interest is compounded, but only APR accounts for fees.

APR is designed to give you a more complete picture of the annual cost of borrowing. It includes not only the interest charges but also fees associated with the loan, such as origination fees or closing costs. This is why a loan’s APR is often higher than its advertised interest rate.

On the flip side, APY is designed to show you the total amount of interest you will earn in a year. APY reflects the stated interest rate plus the effect of compounding, but since savings products typically don’t have fees, what you see is what you get with APY.

APR vs. APY and You

You'll come across APR and APY in various financial products, so here are some questions to consider for making smart saving and borrowing choices.

Am I getting the best rate?

APR and APY can differ depending on the lender and your credit status. To snag the lowest APR, keep your credit score in great shape and compare offers from multiple lenders. For the best APYs, don't hesitate to explore different banks and account types.

Can I increase my APY?

Besides comparing options, you can boost your APY on CDs and deposit accounts by being flexible. CDs pay a fixed rate for locking in your money for a set time, and their APYs can vary by term length and deposit size. Savings and money market account APYs can also change based on the initial deposit. If you're okay with putting in more upfront or locking your money in for the best CD rate, you could earn more.

Will my APR or APY change?

It depends on the product. A loan with a fixed-rate APR stays the same, but a credit card with a variable APR won't. Similarly, savings account APYs are variable, while most CDs have fixed rates. If you're using a credit card with a low introductory APR, make sure you know the regular APR and when it starts.

What APR will I pay?

Your lender must tell you your APR. Credit cards have different APRs for various uses, like cash advances and regular purchases. Check your cardholder agreement to see which APR applies to each type of transaction.

Best Regards,

Stock Market Charlie