Difference between APY and APR

As hard money lenders, we are often asked, “What is the difference between APY and APR.” Both are used to calculate interest for investment and credit products. And both drastically affect how much you earn or have to pay when applied to your account balance.

APR (Annual Percentage Rate)

APR represents the annual rate charged for earning or borrowing money. APR includes fees and additional costs associated with the transaction, but it does not include the annual compounding of interest within a specific year. Rather, it is a simple interest rate that is calculated by multiplying the periodic interest rate by the number of periods in a year in which the periodic rate is applied. Again, this does not include how many times the rate is applied to the balance.

APY (Annual Percentage Yield)

APY, or annual percentage yield, also known as earned annual interest (EAR), factors in compounding interest, where APR (annual percentage rate) does not.  Simply stated, compounding refers to earning or paying interest on previous interest, which is added to the principal sum of a deposit or loan. Most loans and investments use a compound interest rate to calculate interest. All investors want to maximize compounding on their investments, but at the same time minimize it on their loans. Compound interest is different from simple interest because compound interest is the result of multiplying the daily interest rate by the number of days between payments.

A note to borrowers

As a borrower, you are always searching for the lowest possible rate. When looking at the difference between APR and APY, you need to be informed because a loan might be disguised as having a lower rate. PMF Partners uses simple interest. This is based on the principal amount of a loan. Simple interest is calculated only on the principal amount of a loan so it’s easier to determine than compound interest.