It's very strange. I see a lot of people reaching my blog when they search for information on converting APR to APY or vice versa. They end up on my post last year Interest Rate: APY and APR which mentioned two Excel formula: EFFECT which converts APR to APY, and NOMINAL which converts APY to APR. While it's nice to know that 5% APR is 5.13% APY and 5% APY is 4.88% APR, I think they are missing the big picture. The difference between APR and APY is not a big deal.
If someone is carrying a car loan at 4.99% APR and the interest rate on an online savings account is 5.30% APY, is this person better off keeping the money in the savings account or paying off the car loan? Do I need to convert one to the other and compare the numbers? Not really. The difference between APR and APY is so small you can pretty much ignore it. What makes a much bigger difference is taxes. You have to pay federal and state income taxes on the interest earned in a savings account. There is no tax deduction for the car loan. Therefore, before taxes, 5.30% APY and 4.99% APR are about equal; after taxes, 5.30% APY is much smaller than 4.99% APR.
So, if anyone comes to this post again searching for converting APR to APY or converting APY to APR, please stop. Forget it. It doesn't matter. Look at the effect of taxes instead.
3 comments:
TFB - I thought APY and APR were actually important when comparing mortgage rates. I've read that origination fees and other lender fees are included in the APY making it better than APR for comparing mortgage loans. Any comment?
The only difference between APR and APY is compounding. Loan rates are quoted in APR to make them look smaller. Savings account interest rates are quoted in APY to make them look larger. That's all.
Mortgage fees etc. are included in the APR. Comparing APRs is not as useful as people think because the quoted APR assumes you will stay with the loan for the entire length of the loan (30 years). The effect of the fees is much larger if one sells their house and pays off the loan every 5-7 years with a new loan and a new set of fees.
I've been meaning to crunch the numbers on APY vs APR--thanks for giving me permission to skip it!
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