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

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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