APR versus APY: What’s the difference?

If you’ve ever applied for a loan or searched for a savings account, you’ve probably heard the terms APR and APY. They are among the most commonly used terms in financial services. It’s important to understand what these terms mean, and how they differ.

Understanding APR

APR is an acronym that means annual percentage rate. It tells you how much you will pay to borrow money. There are two kinds of APR: fixed and variable.

The term fixed APR means the rate won’t change over the life of the loan. Many home loans and personal loans have fixed APRs. Because the interest rate, and thus the loan payment, remains the same, it may be easier to budget for a loan with a fixed APR.

A variable APR can change because it is tied to what is called an “interest rate index,” like the prime rate published in the Wall Street Journal. If the interest rate index goes up, so would your variable APR, which would make your loan payment increase. Conversely, if the interest rate index goes down, your loan payment will decrease until it reaches the minimum payment allowed. Credit cards and lines of credit typically have variable APRs.

The interest rate is different from the APR

Don’t confuse the APR with the published interest rate on a loan. The APR is a broader measure of the cost of borrowing. The APR reflects the interest rate plus any fees, points, mortgage broker fees or other charges that you pay to get the loan. For that reason, your APR is usually higher than your interest rate.

Understanding APY

APY stands for annual percentage yield. It reflects the amount of money you earn on an investment or deposit account over a year assuming you don’t add or withdraw funds. In general, you want to select investments and deposit accounts with the highest APY, taking into account any associated fees which can reduce your overall earnings.

Like APR, APY can be fixed or variable. The APY on your savings account is variable, but when you open a certificate of deposit, the APY is fixed for the term of your certificate.

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