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If you’ve worked with a bank to borrow money, to save more, or to do a little of both, you’ve probably tangled with interest in some form or fashion. But the experience if you’re borrowing or saving is a little different.
When you drop money into a deposit account, like a savings account, money market account or certificate of deposit (CD), you may see the account APY in various places, or, at the very least, on the promotional information for these bank accounts.
But, when you’re borrowing money, interest is calculated a little differently and loan and credit statements include APRs instead of APYs.
If it’s all interest, shouldn’t the measurements be the same? You’d think so, but APY applies when you’re saving money (think savings accounts, CDs, money market accounts) and APR pops up when you’re borrowing money. We dive into the details here, that is, if you’re interested in learning more.
When you open a savings account, you expect banks to offer a little something in return for leaving your money with them. Banks do this because they then turn around and use that money (your money) to, amongst other things, offer loans at a rate that’s higher than what they’re offering savings customers.
When you take out a loan (including credit cards), things work in reverse. Instead of banks courting your deposits by offering interest so they can turn around and lend it, now borrowers are the ones seeking some financial support. And that financial support comes with a price – interest – in addition to the money that’s being borrowed. It’s a key way lenders earn money by loaning money.
Savings accounts generally tout an annual percentage yield (APY) instead of an interest rate. If you see the APY and interest rate side by side, you’ll notice the APY is usually slightly higher. This is because APY represents the interest rate in addition to the impact compounding can have on your savings over the course of a year. Compounding adds interest you’ve earned to the balance, and the interest rate applies to the bigger balance.
Keep in mind that the APY is a general guideline because if you’ve got a deposit account with a variable interest rate you could earn more interest if the rate rises during the year, and a little less if it drops.
For example, if you know that you will earn a 2.23% interest rate and your account compounds interest daily, like at Marcus, you can get the following:
If you’re borrowing money from someone other than your parents or best friend, like a financial institution, you can expect to pay interest on top of the money you’re borrowing. To ballpark what that loan will cost once you’ve finished paying it off, you’ll want to look at the Annual Percentage Rate (APR).
But what goes into that calculation depends on how you’re borrowing the money, because APRs are calculated differently for loans and credit cards.
The APR summarizes the interest, upfront costs and fees you’ll pay over the course of the year. This summary is expressed as a percentage of the amount borrowed.
Comparing APRs could help you compare loans because they provide a shared baseline – they represent the rate and any upfront fees you’ll pay. There are many factors that go into determining the APR a lender may offer you, however one of the first things you'll want to check is your credit score.
Generally, the higher your credit score, the lower the APR will be. (You can learn more about the credit score you need for a personal loan here).
You’ll also want to read a loan’s fine print to make your decision, but looking at the APR is generally considered a good filter when you’re assessing your options.
For this formula you’ll need to subtract any fees from the loan amount. You’ll also have to multiply the rate by 12 to get the actual annual percentage rate.
Here is what the monthly payment would be in our example:
The APR is the interest rate you are charged on purchases not paid in full by the statement balance due date. If you pay your balance in full and on time, chances are you won’t pay any interest.
But there is a bit more to it than that (had to be too simple, right?). One thing to know about credit card APRs is that a single card could offer different APRs, depending on what you’re using the card for. For example, you could end up with a card that applies one APR to cash advances, another for purchases, and another if you’ve triggered a penalty. Rates can be variable, so the rate you have one month may not be the rate you have the next month.
This calculation includes four steps – finding the Daily Periodic Rate, finding your daily average balance, identifying your billing period and calculating.
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For example, you make one $5,000 charge on the first day of your 30-day billing cycle. Your APR is 25% on a card that calculates interest using the average daily balance.
$5,000 x 0.06849% x 30 = $102.74 in interest you’d pay on that month’s bill if you carried the balance
Typically, when talking about a deposit account – online savings account, certificate of deposit (CD) and NPCD – it’s APY. On the flipside, when you’re borrowing money, like taking out a personal loan or using a credit card, it’s APR. When you’re comparison shopping for a savings account or a loan, make sure you keep this in mind.
However, it’s not the only item to look at. For example, a loan may have additional fees associated with it and personal loan fees can really add up. No matter what, always be sure to read the fine print to ensure you’re making the best choice for your needs.
It’s safe to assume when you’re looking at APY on a savings account that rate reflects compounding interest. On the other hand when we’re talking APR on a loan, that rate is a simple interest rate.
For APY on a savings account, in addition to comparing what the APY is, you should make sure to understand how often the interest will compound as this can have a significant impact on how quickly your money could grow.
This article is for informational purposes only and is not a substitute for individualized professional advice. Articles on this site were commissioned and approved by Marcus by Goldman Sachs®, but may not reflect the institutional opinions of The Goldman Sachs Group, Inc., Goldman Sachs Bank USA or any of their affiliates, subsidiaries or divisions.