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A Guide to Understanding APR & APY

January 01, 2021

When shopping for a mortgage, credit card, savings account or certificate of deposit, it’s important to understand annual percentage rate (APR) and annual percentage yield (APY) so you can evaluate your potential interest rates and intelligently compare offers. Consumers typically look for the lowest available rate on mortgages and the highest rate on savings accounts. Understanding APR and APY will give you a clearer picture of how much you’ll earn or pay. Middlesex Savings Bank can help you navigate this process so you can find the best rates in Massachusetts.

What is Interest?

To understand APR and APY, you first need to understand the concept of interest. Interest is the cost of using someone else’s money and is calculated as a percentage of a loan or a deposit. For example, if Middlesex Savings Bank lends you money in the form of a personal loan, you’ll pay interest on top of the amount borrowed. On the other hand, if you save money through a Middlesex Savings Bank certificate of deposit, IRA, Money Fund or savings account, you’ll earn interest based on current rates

Another term to understand is compound interest, which is the interest paid on the principal (original amount of loan or savings deposit) plus the interest earned or paid over previous periods. The more often your interest is compounded, the more interest you’ll either earn or pay. 

Using APR to Compare when Borrowing Money

When shopping for the best mortgage, credit card or loan, most consumers hunt for the lowest interest rate. However, some lenders who offer very low interest rates have high closing costs and fees, which makes the loan much more expensive. This is a common practice in the payday lending industry and for online mortgage lenders. While interest rate is important, be sure to also consider fees and other costs when shopping for a loan. Compare using APR to ensure you’re getting best deal.

APR is the total cost of borrowing money, calculated annually over the lifetime of a loan. The APR calculation takes several elements into account to give you the true total so you can compare offers from different lenders. Let’s use two mortgage quotes to understand this further:

Home Loan Costs Bank 1 Bank 2
Loan Term 30 years 30 years
Loan Amount $150,000 $150,000
Interest Rate  3.50% 3.75%
Closing Costs $6,000 $1,000
APR 3.82% 3.80%
Monthly Payment $701 $699.30
Total Interest $102,183.50 $101,750

As you can see from this example, Bank 1 offers a lower interest rate but much higher closing costs. Bank 2 offers a higher interest rate with lower closing costs. APR calculations show us that the loan total is actually less for the mortgage from Bank 2, even though the interest rate is higher. 

It’s important to note that other factors like your credit score come into play when determining your actual interest rate and APR. Be sure to also compare the loan terms when looking at various offers. A Middlesex Savings Bank mortgage specialist or representative can help you make an informed decision. 

Using APY to Compare Deposit Accounts

When shopping for a CD or savings account, the best way to compare options is by looking at APY. APY considers both the interest rate and frequency of the compounding interest. The higher the APY, the more money you’ll earn. Banks and credit unions have various compounding frequencies. Some offer daily compounding, while others compound monthly, quarterly or annually.

“You Earn a Yield and Pay a Rate”

An easy way to remember the difference between APR and APY is to use the adage, “You earn a yield and pay a rate.” It’s important to understand how interest works and which calculations you should use to compare offers on loans, savings accounts, money market accounts or CDs. If you’d like to talk to us about our savings options or meet with a mortgage specialist, contact Middlesex Savings Bank or visit one of our Massachusetts branches

by Middlesex Savings Bank