What is APR?
Let’s start with the simpler term, annual percentage rate (APR). APR is the rate of interest a lender earns on their money and that a borrower pays for using it.
After one year, a person can expect to have $2,000 in interest from a savings account with a 20% annual percentage rate. Interest is calculated by multiplying the principal amount and the annual percentage rate so, after one year, you will have $12,000 in your savings account. After two years, you will have $14,000 and after three years you will have $16,000.
Rather than getting a bonus at the end of 12 months, you will receive interest backed by your deposit each month.
If you put $10,000 into a 20% APR bank account and let it compound monthly for a year, you’ll get $12,429. But if you compounded 100% of the interest daily, you would end up with $12,452.
The compound interest earned over a longer period of time can be much more impressive. Whereas with compounding and the same 20% APR product, you would earn an extra $3,309 in three years.
You’ll earn a lot more when you incorporate compound interest into your money. Your interest is also different from the compounding frequency – higher when it’s more frequent. Daily compounding yields more interest than monthly compounding, for example.
The formula for calculating APY is the same as APR with one exception. To calculate APY, you’ll also take into account how often the interest will compound. In order to compare bank products that offer different compounding frequencies, you’ll use this conversion table to convert from APR to APY.
Your APR should be quoted as a fixed annual rate, while your APY will account for compounding interest. One way to remember that is to recall that “yield” has one more letter of the alphabet than “rate.” The yield also represents more complex calculations and higher earnings.
What is the difference between APR and APY?
You should compare rates using the same term of APR vs. APY to be mindful that you may be comparing apples to oranges because different products may use one or the other, but both are still interest rates.
The interest rate does not always dictate the amount of interest earned. You can find an interface for converting the percentage rate by compounding frequency online.
When looking at crypto products, be sure to convert the APYs and APR so that you can compare apples to apples
Make sure that Defi products you are comparing have the same compounding terms if they have the same APY. One example would be USDAP and APY: the US, where one compounds monthly and the other daily.
It is important to know the difference between using APY in financial product collateral for cryptocurrency returns and the predicted returns or yield. US-based stocks, for example, are quoted in terms of dollars per share, whereas stocks in other countries are quoted in terms of their currency.
The best way to calculate APR and APY
When looking for interest rates, you have to make sure you understand whether or not the rate is compounded more than once per year. The annual percentage yield (APY) incorporates compound interest. In this sense, APY always has higher numbers because of the effects of compounding interest on interest–making it a more complex metric.
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