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Do you know the difference between APY and APR? It could determine how much money you gain - or owe.
Annual percentage yield (APY) and annual percentage rate (APR) are two ways to express the interest that accumulates on some financial products. The APY is the rate interest accrues to a savings account and some checking accounts; the APR is the rate interest accrues to debt, such as a mortgage loan or line of credit.
In other words, the APY is how much you can earn in interest, and the APR is how much you’ll have to pay in interest.
APY and APR are never used on the same financial product. You’ll never have to pay interest on a savings account. Likewise, you’ll never gain interest on debt that you owe. But they each tell you the same thing: the maximum rate of interest you can earn for that year for a given balance.
The APY and APR tell you the rate at which your balance will increase each year, but interest is only part of the equation. For loans, the APR might include other fees, like discount points and small percentage fees owed to the loan servicer. The APY on a bank account could decrease based on fees and changes in the market, so the APY you’re quoted on your account is usually the best rate the bank or credit union can offer at that time.
The annual percentage yield is the amount you earn on a savings account and some checking accounts. For the most part, you should receive the amount you see when you sign up. If you deposit $1,000 into an account that earns 1.90% -- a recent common APY on online bank accounts – then 12 months later you’ll have $1,019.
The APY on a savings account depends on the bank and type of account. You may see anywhere from 0.01% APY to over 3% APY. The latter is usually called a high-yield savings account, and high interest is usually associated with certificates of deposit.
Additionally, in rare cases, checking accounts also gain interest. Interest on checking accounts typically never exceeds 0.70% APY.
You may see a separate interest rate, and it could be a few hundredths of a percentage point lower than the APY. That’s because the interest on deposit accounts is compounding, which means that, every month, a fraction of the interest is applied to the account, and you begin earning interest on the sum of your balance plus the fraction of earned interest. These fractions, usually one-twelfth of the stated interest rate, add up to the APY across a twelve-month span.
That means that, each month, the interest you earn should be slightly higher than what you earned for the previous month, but the sum total will be less than the APY. To earn the full APY for a given deposit, you need to keep the money in there for a year. If you withdraw or spend the cash before the year is up, you may only have earned a part of the interest up to that point.
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Investments also gain interest, as long as the market is doing well. But interest on investment accounts is typically expressed as the annual percentage return. Since investment returns hinge on the assets performing well, no interest is ever guaranteed, and there is some level of risk.
However, in return for that risk, you could earn a much higher rate of return. You should use a savings account to earn a consistent APY and an investment account to grow your money faster.
The APR is the rate at which the principal balance on a loan accrues interest every year. The APR could also include points, which may be extra fees paid to the loan servicer for the origination of the loan, and discount points, which help pay down your loan faster. Other types of debt, like mortgages, have their own unique fees included in the APR, like private mortgage insurance premiums.
The APR is used for credit card debt, mortgages, auto loans, personal loans, business loans, and student loans.
The APR is also composed of compounding interest. As you pay down the loan balance, a part of the payment goes toward the interest and part of it goes toward the balance. Your interest payments are calculated based on the remaining balance you’re expected to have after making the payment. Therefore, the longer you’ve been paying off the principal, the lower your APR should be, as your monthly payment increasingly goes toward the balance instead of to interest.
The APR may vary a lot between financial products. For example, it’s common to have an APR of just over 4% to just over 5% for a 30-year, fixed-rate mortgage. But the APR on credit card debt could be as high as 14% to 27%.
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