13.5. APR and APY (Nominal and Effective Rates) http://www.ck12.org
13.5 APR and APY (Nominal and Effective Rates)
Here you’ll learn how to compare rates for loans and savings accounts to find more favorable deals.
In looking at an advertisement for a car you might see 2.5% APR financing on a $20,000 car. What does APR mean?
What rate are they really charging you for the loan? Different banks may offer 8.1% annually, 8% compounded
monthly or 7.9% compounded continuously. How much would you really be making if you put $100 in each bank?
Which bank has the best deal?
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A nominal rate is an interest rate in name only. Banks, car dealerships and all companies will often advertise the
interest rate that is most appealing to consumers who don’t know the difference between APR and APY. In places
like loans where the interest rate is working against you, they advertise a nominal rate that is lower than the effective
rate. On the other hand, banks want to advertise the highest rates possible on their savings accounts so that people
believe they are earning more interest.
In order to calculate what you are truly being charged, or how much money an account is truly making, it is necessary
to use what you have learned about compounding interest and continuous interest. Then, you can make an informed
decision about what is best.
APRstands forAnnual Percentage Rate. It is a nominal rate and must be compounded according to the terms. The
terms are usually monthly, sok=12.
APYstands forAnnual Percentage Yield. It is a true rate that states exactly how much money will be earned as
interest.
Example A
If a credit card advertises 19.9% APR (annual rate compounded monthly) and you left $1000 unpaid, how much
would you owe in a year?
Solution:First recognize that 19.9% APR is a nominal rate compounded monthly.
FV=?PV= 1000 ,i=. 199 ,k= 12 ,t= 1