IM’ing about the difference between an APY vs an APR.

by J. Money on Thursday, November 13, 2008

Some of my friends know i’m into finance stuff, and some of them don’t. But i have one friend that def. knows because she’s alllllllways asking me stuff :) And it’s totally cool because she usually asks me things that i don’t know myself all the way – like the difference between an APY(Annual Percentage Yield) and an “interest rate” aka APR(Annual Percentage Rate).

I used to know it, but then i forgot cuz my brain is slow like that. So i googled it and refreshed my memory. Keep in mind my answers to her were skewed a bit because i know her financial history – she’s 100% on top of stuff and never carries a credit card balance. Actually she just got her first c/c the other month to help boost her credit!

Here’s a copy and paste of our IM convo., with our real screennames edited out (i don’t have “J_Money” but i’m sure some lucky ba$tard does!):

(2:36:17 PM) Friend123: question… what is the difference between APY and Interest Rate. Look at the chart on this page, under: What you get.
(2:40:00 PM) J_Money: let me check :)
(2:40:06 PM) Friend123: thanks!
(2:41:40 PM) J_Money: “APR is the annual rate of interest without taking into account the compounding of interest within that year. Alternatively, APY does take into account the effects of intra-year compounding.”investopedia
(2:42:05 PM) J_Money: APY is when you have a balance every month that compounds
(2:42:15 PM) J_Money: and APR (the “interest rate”) is the rate WITHOUT compounding :)
(2:42:26 PM) Friend123: so do you choose how you want it calculated?
(2:42:32 PM) Friend123: why do they list both?
(2:43:12 PM) J_Money: APY is always higher (both regards to savings accounts, as well as credit cards)
(2:43:29 PM) J_Money: so when looking at savings stuff – like cds, rates, bonds, etc, APY is the one you need to look at
(2:43:49 PM) J_Money: and when searching for credit cards, the APR is the one :) that is, if you dont’ ever carry balances
(2:44:04 PM) Friend123: ahh ok
(2:44:09 PM) J_Money: you don’t “choose” anything though…..they both will apply depending on the situation
(2:44:41 PM) J_Money: so w/ CDS and savings and stuff like that, unless you’re only saving stuff for 1 month and that’s it, APY is the one to look at cuz you’ll have it on a monthly basis
(2:45:40 PM) Friend123: why do they show both?
(2:45:41 PM) J_Money: and w/ credit cards, it’s the APR you’re interested in since you never keep a balance :)
(2:45:55 PM) J_Money: cuz they both apply
(2:46:03 PM) Friend123: oh, i think i kinda get it
(2:46:10 PM) J_Money: i’ll come over ;)

It might not be the clearest explanation ever, but i thought it was more interesting for you all to read about it via IM than the other boring ways. If you prefer these boring ways :), or just wanna learn more, check out the Investopedia’s or the Motely Fool’s explanations.

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