APY vs APR: Annual Percentage Yield vs Rate Explained

APY vs APR is a common point of confusion in banking. If you’re new to banking in America you may find this helpful when navigating products tied to your new US bank account for non-residents.

On the other hand, if you are a qualifying US resident, e.g. you have passed the Substantial Presence Test, the information below will still apply to you.

Feel free to use the table of contents to jump ahead to the sections most relevant to you.

Table of Contents

  1. APY vs APR
  2. How to Calculate the Annual Percentage Rate?
  3. How to Calculate the Annual Percentage Yield?
  4. Is an APR or APY Important for a Savings Account?
  5. Frequently Asked Questions
  6. Ready to Open Accounts With Banks in the USA?

APY vs APR

The main difference between APY and APR is that APY (Annual Percentage Yield) is the total return a saver earns in a calendar year while APR (Annual Percentage Rate) is the total financing cost of a borrower in a calendar year.Β 

In other words, both relate to interest rates, but in very different ways. APY refers to the investment returns from compound interest on a savings account while APR refers to the financial terms including bank rates for borrowing to which an individual agrees.

Understanding APY and APR is critical when dealing with investing and borrowing products, this is especially true for foreign and international clients or nonresidents who may not be familiar with local rates for investments or borrowing.

If you are looking to calculate your APR, APY, effective interest rate, yield-to-maturity (YTM), or any other expression of interest rates, there is a wide range of financial calculators available that can assist you.

Needless to say, there is a clear difference between APY and APR, but they are both important concepts for individuals to understand. With this in mind, we have provided a more detailed financial comparison of both APY and APR below, including how they relate to understanding interest rates.

Annual Percentage Yield vs Interest Rates

The main difference between APY (Annual Percentage Yield) and interest rates is that APY takes into consideration the interest rate and the compounding periods applied to a savings account or investment while interest rates only reflect the actual interest applied. In other words, when comparing two savings accounts, you should always look at the APY in order to compare returns on an equal basis.

Annual Percentage Rate vs Interest Rate

The main difference between APR (Annual Percentage Rate) and interest rates is that APR takes into consideration additional fees and charges that impact the overall cost of borrowing while interest rates only reflect the actual rate of interest charged. In other words, if you want to compare two borrowing options equally, you should always look at the APR.

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How to Calculate the Annual Percentage Yield?

To calculate APY (Annual Percentage Yield) you need to have two pieces of information, which are the interest rate and the compounding period. To calculate APY, you will then insert both of these numbers into the APY formula.

Annual Percentage Yield Formula:

APY = [(1 + 0.045/12)^12 – 1]*100

Annual Percentage Yield Formula Explained:

  1. Dividing the interest rate by the compounding frequency,
  2. Adding 1 to the resulting rate
  3. Multiplying the resulting rate by the resulting rate for a total number of compounding periods in one year (e.g. 12 if compounding monthly)
  4. Subtracting 1 to receive APY as a decimal, and
  5. Multiplying it by 100 to receive the APY percentage

How to Calculate the Annual Percentage Rate?

To calculate APR (Annual Percentage Rate) you need to have specific details about the loan, loan amount, interest rate, term, and any additional fees or charges that will be applied. Importantly, fees include closing fees, upfront fees, and other other fees that might be associated with the loan. To calculate APR, you then insert this information into the APR formula.

Annual Percentage Rate Formula:

APR = [(Total Borrowing Cost/Total Loan Amount)/Number of Years)*100

Annual Percentage Rate Formula Explained:

  1. Calculate total interest by multiplying the loan amount by the interest rate by the number of years (term) of the loan.
  2. Add all of the additional fees to the total interest calculated in the previous step, which is the total borrowing cost.
  3. Divide the total borrowing cost by the total loan amount, which is the finance charge.
  4. Divide the finance charge by the total number of years (term) of the loan, which gives you the APR as a decimal.
  5. Multiple the APR decimal by 100 to receive the APR percentage.

Is an APR or APY Important for a Savings Account?

An APY is important for a savings account because it represents the total interest that will accrue on a savings account within a calendar year. Importantly, APY takes into consideration both the interest rate being offered and the compounding periods when the rate will be applied. This means that APR is a more accurate reflection of the total return that an individual will receive on an account compared to the nominal interest rate.

Frequently Asked Questions

Below are three of the most common questions we receive from people looking into APY vs APR. If you have further questions you would like to ask our team, don’t hesitate to get in touch.

What’s the Main Difference Between APR and APY?

The main difference between APR and APY is that APR refers to the total return that an individual will receive on their savings account within a calendar year while APY refers to the total borrowing cost that an individual will pay for a loan within a calendar year.

Why Is APR Higher Than APY?

APR is higher than APY because banks need to generate a return. In short, APR is the total amount of money that a bank charges a borrower on a loan and APY is the total amount of money that a depositor receives on a savings account. To generate revenue from these financing activities, banks need to be able to lend at a higher rate than they pay depositors.

What Does 5.00% APY Mean?

5.00% APY means that the total return a financial institution is offering you on a savings account is 5.00% each calendar year. This figure takes into consideration both the nominal interest rate being offered and the compounding periods when the interest rate will be applied.

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GlobalBanks Team
GlobalBanks Team

The GlobalBanks editorial team comprises a group of subject-matter experts from across the banking world, including former bankers, analysts, investors, and entrepreneurs. All have in-depth knowledge and experience in various aspects of international banking. In particular, they have expertise in banking for foreigners, non-residents, and both foreign and offshore companies.

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