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When ever you see a rate listed for any financial product one of
these three letters will follow. Did you ever take the time to consider
what it means?
APY is an acronym that stands for Annual Percentage Yield. In English,
if you leave your money with that instrument for one complete calendar
year this is exact percentage of interest you will accumulate. Again
note the one calendar year.
They take into consideration the compounding affect of your interest.
Have you ever noticed that the amount of actual paid interest you
receive on your account increases just a little every month? Your
monthly interest increases even though you have not added any money
to the account. What is happening? They are giving you interest
on the past interest you have received. For example, you put $100
into an account that receives 5% interest APY. The interest is compounded
monthly. You will notice that ever month, you approximately receive
4.888948540378024% in interest. If that is compounded every month,
by the end of the year you will actually receive 5% interest.
APR is an acronym that stands for Annual Percentage Rate. This
does not take the compounding affect of interest into account. It
is offering you a flat rate.
When you are looking to borrow money, you would like to see a rate
in APY. But, you never do. When you are looking to give banks money,
you would like to a rate in APR, but you never do. This is because
it is not an attractive way to package rates. Using the previous
example, if you were borrowing money would you rather see a rate
of 5.0% APY or 4.89% APR? If you were trying to grow your money,
which rate would you prefer? This is where banks take complete advantage
of the APY/APR marketing scheme.
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