It’s in Your Best Interest to Understand APR & APY

Feb 27, 2019 | by Savings Institute
  • Personal Finance

When shopping for a mortgage, credit card, savings account, or CD, it’s important to understand what those APR and APY acronyms mean after the interest rate, so you can intelligently compare offers. Consumers typically look for the lowest rate on a mortgage and the highest rate for a savings account. However, when you look at APR (annual percentage rate) or APY (annual percentage yield), you’ll get a clearer picture of how much you’ll earn or pay, and can more easily compare apples to apples from different banks or credit unions. 

What is Interest?

To understand APR and APY, you first need to understand the concept of interest. Interest is simply the cost of using someone else’s money and is calculated as a percentage of a loan or a deposit. For example, if Savings Institute Bank & Trust lends you money for renovating your kitchen in the form of a home equity loan, you’ll pay interest on top of the amount borrowed to pay for the renovations. On the flip side, if you put money into your Savings Institute interest-bearing checkingCDsMoney Market or Savings account, you'll put more money into your pocket, based on the current interest rate

Another term to understand is compound interest, which means the interest you are paid on the principal also earns interest –so your interest earns interest. The more often your interest is compounded, the more money you’ll either earn or pay. 

Using APR to Compare When Borrowing Money

When shopping for the best mortgage, credit card, or loan, most consumers shop around for the lowest interest rate. However, some lenders offer very low-interest rates but have high closing costs and fees, which makes the loan more expensive. This is a common practice in the payday lending industry and with online mortgage lenders. So, what’s a borrower to do? Compare using APR!

credit cards and mortgage costs aren’t only made up of interest rates but include fees and other costs. APR is the total cost of borrowing money, calculated annually over the life of the loan. The APR calculation that takes other elements into account to give you a true total cost of a loan, so you can compare offers from different lenders. Let’s use two mortgage quotes to understand this further:

Home Loan Costs

CT Bank 1

RI Bank 2

Loan Term

30 years

30 years

Loan Amount

$150,000

$150,000

Interest Rate

3.50%

3.75%

Closing Costs

$6,000

1,000

APR

3.82%

3.80%

Monthly Payment

$701

$699.30

Total Interest

$102,183.50

$101,750


As you can see from this example, CT Bank 1 offers a lower interest rate, but much higher closing costs. RI Bank 2 offers a higher interest rate with much lower closing costs. This makes the actual loan total less for the total cost of the mortgage that has a higher interest rate. Thanks, APR!

It is important to note other factors like your credit score*, come into play when determining your actual interest rate and APR. That’s why we’ll provide a Truth in Lending document (TILA) to estimate your APR and will connect you with a Savings Institute mortgage consultant to help you make an informed decision. Also, make sure to compare the same loan terms when looking at various offers. 

Using APY to Compare Deposit Accounts

When shopping for a CD or savings account, the best way to compare accounts is by looking at the APY (the annual percentage yield). APY takes the frequency of compounding interest into effect, as well as the interest rate. The higher the APY the more money you’ll earn. Banks and credit unions have different compounding frequencies. Some offer daily compounding, others compound monthly, or quarterly, or annually. Reach out to Savings Institute, and we’ll talk through what is best for you. 

“You earn a yield and pay a rate.”

An easy way to remember the difference between APR and APY is to use the adage, “You earn a yield and pay a rate.” Understanding how interest works and which calculations you should use to compare offers on loans and savings, money market accounts of CDs is an essential step in becoming financially fit. If you’d like to talk to us about our savings options or meet with a mortgage consultant, please visit us in our branch locations in Connecticut and Rhode Island.

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