Understanding the Difference: APY vs APR
When it comes to understanding interest rates, two popular terms often used are APY and APR. While they both relate to the interest earned or paid on an investment or loan, there are significant differences between them that are important to grasp.In this article, we will explore the difference between APY and APR, and how they can impact your financial decisions.
First, let\“s start with the term APR, which stands for Annual Percentage Rate. This is the annual interest rate that is charged on a loan or earned on an investment, without considering the effect of compounding interest.
On the other hand, APY, which stands for Annual Percentage Yield, takes into account the effect of compounding interest. This means that the interest is calculated on the initial amount as well as on the interest that has been earned or paid over time.
Let\“s consider an example to illustrate the difference. Suppose you have a savings account with an APR of 5% and you deposit $1,000. At the end of the year, you would earn $50 in interest. However, if the interest is compounded monthly, your APY would be higher than 5%, as the interest earned in each month is added to the principal, and interest is then calculated on the new total for the following month.
This distinction between APY and APR is crucial when comparing different financial products, such as loans or savings accounts. It\“s important to understand which rate is being used to ensure you\“re making informed decisions about your finances.
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