A quick guide to interest rate terms when borrowing or earning interest on savings.

As a consumer, interest can be considered from two sides: the cost of borrowing money and the earnings on savings. You’ll the see terms interest rate, APR and APY. Each term means something specific; here’s a guide to understanding the difference between simple interest, APR and APY.

Simple interest

To understand APR and APY you first need to know how interest works. Basically, interest is money paid when one party uses another party’s money. The amount paid is expressed in a percentage.

Let’s look at two examples. When you save money in a CD, you allow a credit union or bank to use your money. In return, you earn money in the form of interest. When you take out a loan, you borrow money from a credit union or bank; you’ll pay interest to the lender.

To calculate simple interest, multiply the principal (the amount of the savings deposit or loan) by the interest rate; this will give you the interest for the year. Divide that number by 12 to get the figure for the monthly interest. For example:

$1,000 x 4% = $40 annual interest

$40 / 12 months = $3.33/month

APR: Annual Percentage Rate

APR, or Annual Percentage Rate, is the term you’ll see when you borrow money. The APR will be higher than the interest rate because it accounts for simple interest plus the cost of the fees. You’ll see APR listed with offers for credit cards, personal loans and mortgage products.

With a mortgage, fees may include points (a fee paid to reduce the interest rate; points are sometimes called prepaid interest), broker fees, application fees and other charges.

While two lenders might offer the same interest rate, there can be a significant difference in their APRs because fees vary by loan provider.

APY: Annual Percentage Yield

APY, or Annual Percentage Yield, is the term used for interest you earn with savings and investment options. APY will be higher than the interest rate because it includes compound interest. Compound interest is a saver’s best friend because interest is earned on interest. Compounding is done periodically: daily, monthly, quarterly or annually.

How to use APR and APY

When you compare things like credit cards, loans and savings accounts, APR and APY give you a complete picture of your total costs or earnings. Look beyond interest rates and evaluate the APR or APY when choosing loan and savings options.

 

All loans subject to approval. Rates, terms, and conditions are subject to change and may vary based on credit worthiness, qualifications, and collateral conditions. Federally insured by NCUA