When it comes to your business finances, it is important to understand the differences between an annual percentage rate (APR) and annual percentage yield (APY). Many people use APR and APY interchangeably because they are both used to calculate interest, and are commonly used to know how much you need to cover in your account balances.
This article will explore the key differences between APR and APY and what it matters for your business’s financial health.
What is an APR?
APR is the amount of interest you’d pay on a loan if you borrowed the money for one year. APR is different from your interest rate because it includes additional fees and charges that may be added to the loan. The APR helps you compare loans with different fees and terms. Do note that the APR does not take into account the compounding effect of interest where it applies.
The APR, according to the Consumer Financial Protection Bureau, elaborates that the APR is a broader measure of the cost to you of borrowing money. This reflects fees that you have to pay to get the loan, as well as any other fees such as service charges, closing costs, insurance, etc.
In general, the lower the APR, the better. However, there are other factors to consider when choosing a loan, such as the length of time you’ll need to repay it and whether you’ll be able to afford it.
When considering a loan, be sure to look at the APR so that you know how much the loan will actually cost you in the long run. This can help you save money and make better financial decisions.
Formula for APR:
APR = Periodic Rate x Number of Periods in a Year
What is an APY?
APY is a measure of how much interest you earn on an investment over the course of a year. It takes into account the interest rate, as well as any compounding that may occur during the year.
The APY is important because it allows you to compare different investments to see which one will give you the most return on your money. It’s also helpful in determining whether an investment is worth your time and money. APY lets you know how much your investment will grow each year, on average.
Formula for APY:
APY = (1 + Periodic Rate)n – 1
*n = number of periods
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What’s the difference between APR and APY?
The simplest way to differentiate APR and APY is this: The APR is a measure of the cost of borrowing money, while APY is a measure of how much you’ll earn on your investment.
The APR is the interest rate that you will pay on your loan or credit card. This rate is typically fixed, meaning that it will not change over time. The APY, on the other hand, is the interest rate that you will earn on your savings account. This rate can vary depending on the financial institution and the market conditions.
APR is simply the stated interest rate on a loan or investment. However, because financial institutions are allowed to compound interest monthly, quarterly, semiannually or annually, the actual interest rate you pay on a loan may be higher than the APR. This is why it’s important to also look at the APY when comparing investment options.
APY takes into account the frequency of compounding interest and gives you a more accurate representation of the true interest rate. In other words, APY will always be higher than APR because it includes compound interest.
An example
The main difference between APR and APY is that APR is the interest rate you pay, while APY is the interest rate you earn. This may not seem like a big difference, but it can have a significant impact on your finances.
For example, let’s say you have a credit card with an APR of 20%. This means that you will pay 20% interest on your balance. If you have a savings account with an APY of 0.50%, this means that you will earn 0.50% interest on your balance.
In the example above, you can see how the APR can have a negative impact on your finances while the APY can have a positive impact.
This is why it is important to understand the difference between these two terms. When you are comparing financial products, make sure to compare the APR and APY so that you can make the best decision for your situation.
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When borrowing money, what should you look at?
For the borrower’s perspective, it is more important to focus on the APR rather than the APY. The main reason for this is that the APR includes all fees and costs associated with taking out the loan, while the APY does not.
In general, APR is more important for borrowers because it provides a more accurate estimate of the true cost of borrowing. This is because APR includes not only the interest rate but also any additional fees or charges associated with the loan. As such, it provides a more complete picture of the true cost of borrowing money.
However, this doesn’t mean that APY is irrelevant. In some cases, it can provide a more accurate estimate of the true cost of borrowing than APR. This is because APY takes into account the effect of compounding interest. For example, if you have a loan with an APR of 12% and a compound frequency of monthly, your APY would be 12.68%.
Therefore, when comparing loans, be sure to compare apples to apples by looking at the APR rather than the APY. This will give you a much better idea of which loan is actually cheaper and will save you money in the long run.
To summarize
The APR is the interest rate that you’ll pay on your loan. This is the amount of interest that will accrue over time, and it’s expressed as a percentage of the total loan amount. The APY, on the other hand, takes into account the effects of compound interest. This means that it not only includes the interest rate, but also any fees that may be associated with the loan.
The bottom line is that both the APR and APY are important when you’re borrowing money. Be sure to consider both numbers when seeking funding from traditional lenders or any financial institution.
