Question:

Interest rate vs. annual percentage yield (APY) vs. annual percentage rate (APR) - what is the difference?

Answer:

Interest rate, annual percentage rate (APR) and annual percentage yield (APY) are three different terms though they are somewhat similar in their nature.

Let's start with the simplest one of these terms - interest rate. When you take a mortgage loan interest rate is the price you will have to pay for the use of money you do not own. Normally, the interest rate will be expressed as a percentage rate over a one-year period.

Thus, we get to the next two terms - annual percentage rate (APR) and annual percentage yield (APY).

Annual percentage yield (APY) vs. annual percentage rate (APR)

It is very important to understand the difference between APR and APY since lending institutions and banks will use both terms according to your dealings with them. Generally, when you get a loan (whether it is a home loan or a loan for a car) you will be quoted the APR since it will be lower. However, if you invest with them, you will be quoted the APY since at the end of the year it will be a higher percentage. Why is that?

Both APY and APR are related to the effective interest rate. However, in contrast to the APR, which is constant per month throughout the entire year, the annual percentage yield (APY) expresses the annual interest rate taking into account the effect of compounding. For example, if the APY starts at 10%, after 12 months it will be 126,8%.  

Compounding is one of the differences between annual percentage rate and annual percentage yield. Another one is that, in contrast to the APY, the annual percentage rate takes into account the costs and fees which borrowers will pay on their loans. The APY doesn't take transaction costs into consideration.

Mortgage rates hit their lowest since 1955. Ask the home loan experts we recommend Quicken Loans how to take advantage of them.
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