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APR vs. APY: What’s the Difference?

APR (Annual Percentage Rate) and APY (Annual Percentage Yield) are both ways to express the interest rate on an investment or loan. The main difference between the two is that APR is a simple interest rate, while APY takes into account the effect of compound interest.

APR is the annualized interest rate on a loan or investment, expressed as a percentage. It is calculated by dividing the interest earned on an investment or paid on a loan over a one-year period by the principal (initial amount invested or borrowed).

APY is the total return on an investment or loan, taking into account the effect of compound interest. It is calculated by dividing the total amount of interest earned on an investment or paid on a loan over a one-year period by the principal.

To calculate the APY on an investment or loan, you need to know the APR and the frequency of compounding (how often interest is added to the principal). The higher the compounding frequency, the higher the APY will be for a given APR.

For example, if you invest $100 at a 5% APR with monthly compounding, the APY would be slightly higher than 5%. This is because the interest earned each month is added to the principal, so the amount of interest earned in the following month is based on a slightly larger principal.

In general, it is important to compare the APR and APY when evaluating different investment or borrowing options, as the APY will give you a more accurate picture of the total return or cost of an investment or loan.