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Interest Rates: APR & APY
3 min read
As many of you already know, the interest rate is the cost of debt for the borrower and the rate of return for the lender. It applies to most lending or borrowing transactions.
The difference between the total repayment amount and the original loan amount is the interest accrued. In the course of calculating such interest for investment and credit products, people come across terms like APR or APY and can easily misunderstand them. These are the indicators of how much you'll earn or must pay when they are applied to your account balances.
What is APR?
Annual Percentage Rate (APR) is the simple interest rate applied to the amount of investments/loans per year. Most often, APR is calculated when considering loan terms, and how much you’ll have to pay to borrow. It may also comprise additional fees and other associated loan costs.
APR is calculated as follows:
APR = Periodic rate X Number of periods per yearLet’s say you are charged with 2% interest each month. Therefore, the APR equals 24% (2% x 12 months = 24%).
What is APY?
Annual Percentage Yield (APY) is the compound interest rate applied to the amount of investments per year. Unlike APR, APY takes into account compound interest and how often compounding happens in a year. Unlike APR, APY takes into account compound interest and how often compounding happens in a year. It means you earn interest not only on what you’ve invested but also an additional one on the interest you’ve already earned - the effects of intra-year compounding.
APY is calculated as follows:
APY = (1 + Periodic Rate)Number of periods – 1The APY for a 2% rate of interest compounded monthly would be 26.82% [(1 + 0.2)^12 – 1] a year.
Additional things to keep in mind
Compound frequency. Interest rates can be compound daily, weekly, monthly, quarterly or annually. Frequent compounding could earn more for your investments and cost more for your credit accounts.
Fixed or flexible rates. If you have found a good APR/APY, make sure you know how long it’s going to last and what your rate will be once the period ends.
The fine print. Make sure you understand all of the terms and fees. Companies and platforms that provide interest rates may have different structural fees. Some might include fees in their APYs/APRs terms, while others might not.
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