Interest Rates: APR vs. APY (and why it Matters)

When comparing interest rates that a bank offers on a mortgage, home equity line of credit, car loan, credit card, certificate of deposit, or savings account, it’s important to know exactly what rate you are looking at.

Even a 0.5% difference in interest rate could cost you hundreds or thousands of dollars when compounded over years.

This post will serve as a quick primer on interest rate terminology and calculations.






What is Annual Percentage Rate (APR)

Annual percentage yield, or APY, is the effective interest rate, with compounding factored in. For that reason, it is also referred to as the effective APR, or EAR.

Banking institutions have deposit products that compound over various periods – daily, weekly, monthly, annually, etc. They are required to express interest rates in the form of APY, or EAR, so that you can compare rates between institutions.

It is essentially the real rate you are are effectively receiving or paying, when compounding is factored in.

How to Calculate APR and APY
APR = Periodic rate x number of periods in a year

For example, a credit card with a 1% monthly interest rate would have a 12% APR (1% x 12 = 12%)

APY = (1 + nominal APR/n)^n – 1

    n = the  number of compounding periods per year.
    nominal APR is expressed in decimal format (i.e. 12% = 0.12)

For example, a credit card with a 12% APR, compounded monthly, would have an EAR equal to 12.68%. The equation would be (1 + .12/12)^12 – 1 = .1268 = 12.68%

If the credit line compounded daily, the EAR equation would be (1 + .12/365)^365 – 1 = .1274 = 12.74%

Why APY is Important

In any borrowing or investment scenario that involves compounding and/or fees, you want to know what the EAR (APY) is.

In a mortgage or loan scenario, you’ll want to know what the EAR is after closing or other fees are factored in.

In a credit card scenario, companies will often quote you a nominal APR (annual percentage rate). However, since your balance compounds monthly, you do not end up paying the nominal APR. Due to the compounding, your EAR will be higher.

Knowing EAR allows you to compare apples to apples and make precise calculations.

APR vs. APY Discussion:

Do you ever feel like you were misled by a bank or credit card company when only being presented with APR vs. APY?

source: 20somethingfinance.com

RBA to ban excessive card fees

The RBA is finalising a new surcharging standards which it hopes will stop businesses imposing excessive credit card charges on customers

Under the proposal, credit card providers such as Mastercard or Visa will be able to restrict the amount businesses charge customers for transactions on their cards.

RBA assistant governor (financial system) Malcolm Edey said on Tuesday that a draft revision of surcharging standards was in the final stage of consultation.

He said the new standard would limit the surcharge imposed on customers, though it may not necessarily be capped at the cost of the transaction.

Dr Edey said he hoped the changes would lead to lower transaction costs for businesses and consumers.

He said credit card providers would be able to take action against businesses that imposed excessive surcharges on customers while still allowing businesses to recoup the costs of transaction.

'In that way I think it strikes a reasonable balance and it should strengthen the incentive for schemes to compete in lowering their fees to merchants,' he said.

'The less a scheme costs to merchants, the lower will be the permissible surcharge.'

Dr Edey said there was anecdotal evidence that some businesses were imposing a surcharge above the cost of the transaction.

Some businesses were levying the same fee on consumers for low-cost cards as those with high-cost cards and that others had imposed a surcharge that was simply well above the cost of the transaction, he said.

'Although these practices do not appear to be widespread, they are of concern from a payments-efficiency point of view because they can distort consumer choices about the payment methods that they use,' Dr Edey said in a speech in Sydney.

'They go against the principle I stated earlier of allowing the efficient flow of price signals to the economic decision-maker.

'It is for these reasons that the (Reserve) Bank reopened consideration of the surcharging standard last year.'

source: http://www.skynews.com.au/national/article.aspx?id=731053&vId=