What is the difference between APR and APY?

Question

I want to open some CDs through my bank, but don't know the difference. I was told that the APY is what you actually get if you leave the interest payments in the account. I'm not sure if that's correct. Does anyone know for sure?

Answer 1

APR is the annual percentage rate (often stated as the interest rate) of the CD and the APY is the annual percentage yield. APY is a better picture of what you will earn for the year or pay if it is for a loan.

An example:

Let's say APR is 5.16%. To figure out APY you can use Excel and see the monthly accrual (some use daily but I am going to use monthly for easiness' sake).

In cell A1 put $100.00
In cell B1 put =5.16%/12 (to figure out the monthly rate of APR)
In cell C1 put =A1*(1+B1) (to figure out your ending monthly balance)
In cell A2 put =C1
In cells B2 an C2 copy the formula from the cell above them

Copy the cells in row 2 down until you have 12 rows filled equaling one year.

At the end of one year you would have $105.28

In this case the APY would be 5.284%

If you have any questions, feel free to email me.

Answer 2

In practice, the only difference is whether you are borrowing or lending.

If you borrow money for consumer purchase, the annual percentage rate (APR) you pay has to be disclosed.

But if you invest your money with a bank in a CD or other deposit, the Annual Percentage Yield they pay you has to be disclosed.

But they are the same concept. Its a standardized measure of annual cost of funds to the borrower or yield to the lender.