Money 4 Today — everyday money arithmetic | money4today.com
APR is the yearly cost of borrowing including fees; APY includes compound interest. Here both are shown at 3, 5, 10 and 24 percent with monthly compounding, and what each means on a loan versus savings.
APR, the annual percentage rate, is the yearly cost of a loan including fees, expressed as a percentage. The U.S. Truth in Lending Act of 1968 requires lenders to disclose it, which makes APR the standard number for comparing loan offers. On a credit card, recent Federal Reserve data put the average above 20 percent — far above mortgage or car-loan rates.
APY, the annual percentage yield, includes compound interest. A 5.00 percent APR savings account with monthly compounding pays an APY of about 5.12 percent. The gap between the two numbers is exactly the effect of compounding over twelve months.
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At 3 percent APR with monthly compounding, APY is about 3.04 percent. At 5 percent, about 5.12 percent. At 10 percent, about 10.47 percent. At 24 percent, about 26.82 percent — the higher the rate, the wider the gap, because each compounding period adds a larger amount.
On a loan, compounding works against the borrower, so APR is the figure to watch. On savings, compounding works for the saver, so APY is the higher and more useful figure. The same account can honestly advertise both numbers, and they will not match.
The Consumer Financial Protection Bureau, a U.S. agency created in 2011, publishes plain-language explainers of APR, APY and credit costs. Reading the APR disclosure before signing is the cheapest form of comparison shopping.
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