Annual Percentage Yield
Annual Percentage Yield, APY, is the rate of return on an investment for a one-year period that is calculated based upon compound interest. It is important to understand the difference between APR, which is annual percentage rate, and APY. Both rates are somewhat similar in nature, but the difference in annual percentage yield is that it takes compound interest into consideration and APR doesn’t. For instance if an APR is 1% per month, at the end of the year, you’ll get the rate of 12* .01= 12%. The APR is constant per month for each month throughout the entire year. However if the APY rate starts at 1%, at the end of the twelfth month, it’ll end up being 12.68%, which is higher than the APR. The way to calculate the APY is by adding one to the percentage rate and raises it to the number of periods in one year, which are usually 12 minuses one.
For examples, a 1% per month rate has an APY of (1.01^12 -1) or 12.68% at the end of the year.
Banks and other lending institutions will used both terms depending up the nature of your transaction. If you are getting a loan for a car or mortgage, banks often quote you the annual percentage rate because it is lower, but if you are investing with them, like buying a bond, CD, stocks, etc., they often quote you the annual percentage yield, which is higher at the end of the year. So before you decide on a loan, make sure you understand the difference between annual percentage rate and annual percentage yield. If some banks do not disclose the APY, you may consider asking them to provide the information. After all you will be the one held responsible to pay according to the rate given. The APY can make a big difference especially when it comes to paying off a 20-30 year loan.
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