‍

How do they differ?

Basically, we could say that the APY(Annual Percentage Yield) takes into account compound interest, while the APR(Annual Percentage Rate) does not.

But the differences go beyond that...

The APR reflects the real cost of a loan or other debt. For this reason, the main person interested in knowing it is the borrower, who wants to apply for a loan.

The APY reflects the real return on an investment. For this reason, the main person interested in knowing it is the investor.

Both the APR and the APY can be used to value investments and loans. But because of the characteristics we will see below, the APR is more appropriate for analyzing loans and the APY for analyzing investments.

The calculation formula for both includes the interest rate.

The difference is that the APR includes, in addition, all other fees and expenses of the contract, while the APY shows the impact of compound interest on your investment (and, therefore, the true return).

‍

‍

How is the interest rate calculated?

If you have seen the formula above, you will have noticed that interest is calculated differently.

We could define interest as the amount (usually annual) charged by the lender for lending you a certain amount of money (the principal). This interest is added to the principal, and the borrower must pay the total amount.

‍

‍

However, there are two different methods of computing this interest:

Simple interest: the principal (P) is multiplied by the nominal interest rate (I) for the years of the loan (T). This is the method used by the APR.

Compound interest: it is the interest of a capital to which its yields or interests are accumulated so that they produce others. This is the method used by APY.

‍

‍

In other words, compound interest allows the initial capital to increase with the same interest it generates, exponentially increasing the amount of capital invested in each period and obtaining a higher profit in each year; simple interest does not.

‍

APR

Although in the world of finance the use of English is extremely widespread, you can find it in some places by its Spanish translation "tasa de porcentaje anual".

As mentioned above, the APR does not take into account compound interest, but it does take into account the expenses derived from the loan contract. These expenses usually correspond to commissions of:

• Opening
• Closing
• Maintenance
• Warranty
• Etc.

Therefore, knowing the APR can be useful when comparing the real costs of different loans.

For example, it can help you decide between a loan with a higher nominal interest rate but lower fees, and the opposite case.

‍

APY

Like the APR, the APY has a Spanish translation. In this case, you will find it as "annualpercentage rate of charge" (the famous APR).

Although the APY can also be used to compare loans, it is actually less useful than the APR, as it tends to have quite a few fees and you need to know them.

‍