If you are planning on purchasing a home, it’s important to understand the difference between annual percentage rate (APR) and annual percentage yield (APY). These two items differ enough in how they work that they can significantly affect how much you pay each month in interest.
APY is a percentage rate showing the total amount of interest paid on an account based on the interest rate and the frequency of compounding for a 365 day period. For example, if you have a high-yield online savings account, APY determines how much interest was paid on that account. It does not take into consideration fees associated with that account.
APR, on the other hand, is the periodic rate of interest multiplied by the number of periods in the year. It’s the amount of money that the lender charges you for borrowing money, like a home loan.
Unlike APY, APR does not take into account any intra-year compounding interest or how the interest is applied to your balance. This difference means that even though you were quoted a particular APR, you may end up paying more over the life of your loan. So it’s important that you do not use APR as your only measure of comparing home loans.
When you start looking for a home loan, you are most likely to choose a lender that offers the lowest interest rate. After all, lower is better right? Not necessarily. Before you chose a home loan with the lowest interest rate, you will want to know how much the actual APR is.
If you don’t, you could end spending more than you would with a lower interest that has a higher overall APR. The reason being, banks will often quote you for APR which does not take into account compounding. Both APR and APY are ruled by the Truth in Savings Act and the Truth in Lending Act.
Before you make any type of decision that involves an interest rate, be it an auto loan or a home loan, speak with your financial advisor. They will go over all of your numbers and fees with you to make sure you are being quoted the correct rate and help you make informed decisions.
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