If you are someone who invests or borrows money, you have probably heard of the terms APR and APY. But most people do not know exactly what these two mean and what the difference between them is. That’s why today I will try to clarify this topic.

Let’s start with a simple question: what does APR mean? In short, APR (Annual Percentage Rate) is a simple measure that shows the annual interest rate of a loan or investment. It is calculated only on the principal amount and does not include the effect of compound interest. You often encounter this in credit card interest rates, consumer loans, and mortgage loans.

But there is a problem here. Since APR is calculated only on the principal, it does not give the full picture of the actual return. For example, if a credit card offers 15% APR, this is just the basic rate. It does not account for the process of compounding interest throughout the year.

This is where APY comes into play. APY (Annual Percentage Yield) is a more realistic measure that also considers compound interest. It shows the total return resulting from interest being calculated and added to the principal daily, monthly, or quarterly. Thanks to compound interest, the actual gain or cost on an investment or debt is reflected more accurately.

Why is the difference between these two important? Because how often interest is compounded can make a big difference. There can be significant differences between daily compounding and monthly compounding. For example, when comparing 15% APR and 15% APY, the investor will earn more at the end of the year with the APY calculation.

APY is used in investment tools such as bank savings accounts, investment funds, and crypto staking. Because in these areas, compound interest really matters, and investors need to know how much they will earn.

In conclusion, it is not enough to look only at APR when making financial decisions. Considering the effect of compound interest and examining APY will be a much more profitable and informed choice in the long run. Especially at high interest rates, this difference becomes even more pronounced.