APR and APY might look quite similar, but they measure different things. Knowing what they mean can help you make better financial choices, especially in the context of cryptocurrency.
What is APR?
APR, or Annual Percentage Rate, is the amount it costs to borrow money over a year. In crypto, it’s commonly used for loans or staking rewards. It’s just the interest rate alone, but it doesn’t factor compounding into APR.
For instance, if you borrow a crypto loan of $1,000 with a 10% APR, you will have to pay $100 in interest after one year. That is without additional fees or compounding.
In DeFi, APR often gets applied to borrowing or lending tokens. If you’re lending out stablecoin with an APR of 5%, in a year’s time, that’s 5% of principal. But remember, APR does not consider how often you get paid or how reinvesting those payments can grow your returns.
What affects your APR?
Many things can determine your APR, for example:
- Credit Score: If you have a good credit score, you’ll get a low APR, but if you have a bad credit score, you might get a high APR.
- Loan Type: Various loans carry different APRs. For instance, a mortgage will have a lower APR compared to a credit card.
- Lender: For the same type of loan, various banks or lenders may provide different APRs.
- Loan amount and term: The amount you borrow and how long you take to repay it can change the APR. So, shorter loans may have lower APRs.
- Market Rates: If interest rates in the economy increase, your APR may increase.
- Down Payment: The more significant the down payment, the better the APR given by the lender.
APR vs. Interest rate
APR and interest rates are similar but not the same. The interest rate is the base rate, while APR includes fees. For example, if you take a crypto loan with a 5% interest rate and a 2% platform fee, the APR becomes 7%. APR helps borrowers understand the total cost of borrowing.
What is APY?
APY, or Annual Percentage Yield, will measure how much you earn on your savings or investment, with the compounding interest. Compounding occurs when the interest you are earning is added to your original amount and then that total earns interest on it. In crypto, compounding may happen daily, weekly, or monthly depending on a given platform.
For example, if you deposited $1,000 in cryptocurrency into a savings account with a 5% APY, compounded monthly, you’ll earn a bit above $50 for a year. This is because every month, your earnings are added to your balance, raising the amount that future interest gets computed on.
APY vs. interest rate
The interest rate only reflects the simple annual return, whereas APY takes into account compounding. For instance,