APR and APY are two ways to calculate interest on investing money or taking out loans or credit. APR reflects the simple interest rate over a year’s time, while APY describes the rate with the effect of compounding, or the interest on interest.
What is compounding?
At its most basic level, compounding refers to earning or paying interest on previous interest, which is added to the principal sum of a deposit or loan. Most loans and investments use a compound interest rate to calculate interest. All investors want to maximize compounding on their investments, and at the same time minimize it on their loans. Compound interest differs from simple interest in that the latter is the result of multiplying the daily interest rate by the number of days between payments.
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