APY vs Interest Rate - What's The Difference? (How Are They Calculated?)

APY vs Interest Rate - What's The Difference? (How Are They Calculated?). In this comparison video I will talk about APY vs Interest Rate.

So, the main difference between them is the interest terms.
Interest rate is the overall percentage of interest on your loan, investment, or savings account. It's what you pay when borrowing money or earns when loaning your cash.
On the other hand, annual percentage yield (APY) is the percentage of interest you earn and the rate at which it accumulates when you keep money in your savings account or certificate of deposit for a year. This means your interest will earn interest.
Therefore, APY terms are favorable as they account for compound interest.

Calculation and representation
Interest rates show your potential earnings without considering compounding. It's calculated using this formula: Interest = Principal x Rate x Time, where Principal is your initial deposit, Rate is the interest rate, and Time is the duration.
For example, if you lend $20,000 at 2% interest, you earn $400 annually ($20,000 x 2 / 100 = $400).
On the other hand, Annual Percentage Yield (APY) considers compounding. It's calculated as APY = (1 + r/n)^n - 1, where r is the yearly interest rate and n is the number of times interest is being compounded.
For instance, with a $20,000 deposit and 2% APY compounded monthly, APY = (1 + 0.02/12)^12 - 1 = 0.020 or 2.02%. So, your total balance after a year would be $20,404.
Therefore, APY terms provide a proper presentation of your potential earnings.

But do they have any similarities?
Yes. Both APY and Interest rates are terms presenting your potential earnings or returns from a savings account, investment, or loan.

To sum up, how do they compare - APY or Interest rates?
I like interest rate terms since when opting for loans with lower rates, I end up paying lower interest throughout the lifespan of the loan. However, I like APY terms more because they provide higher interest rates, and the compounding factor makes it possible for me to maximize my earnings. For these reasons, APY is the overall winner.

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