What is the difference between APR and interest rates?
In: Economics
In short, an APR (Annual Percentage Rate) *is* an interest rate.
The difference you see between interest rates of the same product can be attributed to how the quoted rate is accounting for compounding. In the case of an APR, it doesn’t account for any compounding. Quick example below..
A loan has an interest rate of 1%/month. Since there are 12 months in a year, 12 x 1% = 12% = APR.
However, since that loan charges 1% of interest every month, you will now owe 1% of interest on the interest you accrued the month before. To account for that, we compound the interest – 1.01^12 = 12.68% = EAY/EAR (Effective Annual Yield/ Effective Annual Rate)
This is a better representation to the actual costs of taking this loan. APRs are often quoted as the rate for the person lending since it seems less than what you pay, and the inverse is true for people looking to invest in the loan because a higher rate of return is more appealing (and accurate for calculation purposes)
**ELI5 (Attempt) ** – Your teacher will give you a bank of 10 points for extra credit to use on your final (finger painting) exam. For every month you don’t miss a day, she/he will give you 1% more bonus points than you have in your bank. (12% APR).
The actual realised amount of bonus points is more because ever month your bank grows 1%, so each consecutive months you are taking 1% of a larger number.
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