Annual Percentage Yield, or APY, applies to interest-bearing deposit accounts, while Annual Percentage Rate, or APR, pertains to the cost of borrowing money. The methods might sound similar, but knowing how they differ is important for your financial planning.
Defining APY and APR
APY is the interest you earn on a deposit account over a 1-year period. The higher the APY, the faster your balance grows.
APR is the interest you pay on loan products such as mortgages, credit cards or auto loans over a 1-year period.
APY and the benefit of compounding interest in deposit accounts
Compounding interest is interest paid on the initial account balance as well as on interest earned in prior periods. This helps your money grow faster. The more frequent the compounding periods, the greater the interest earned. Put another way, you will earn more if interest is calculated quarterly rather than annually, and even more if it is calculated monthly rather than quarterly. Let’s take a look at how this works:
APR and the expense of borrowing money
With some loans or credit products, you pay interest only on the principal, or initial borrowed amount. This is called simple interest. Others charge compounding interest, meaning your future payments include not only the principal amount, but interest on whatever past interest payments you have not paid in full. Let’s look at 2 examples:
Mortgages: Most mortgages charge simple interest. There is no interest charged against the interest added to your balance each month.
Credit cards: Credit cards usually charge compounding interest, meaning your monthly payment includes interest on your original purchase balance plus interest on the portion of a previous interest charge you didn’t cover in a past payment.
To sum up, both APY and APR are calculated on an annualized basis. APY is money you earn on interest-bearing deposit accounts, while APR is total cost, including fees and interest, to borrow money. As you think about your financial planning, it’s important to understand what both of these terms mean.
Generally, you want to look for a higher APY on your savings products and a lower APR on your borrowing products. However, that’s not the only consideration, so it’s important to fully understand the terms and conditions of any banking service, deposits or loans, before you make any decisions. A CIBC personal banker can help answer your questions.