What is APR and what does it have to do with your earnings on your savings account?
Annual Percentage Return (APR) is a termed coined in the United States to help understand the yearly amount of interest you should earn on a savings account. This should not be confused with Annual Percentage Rate (also known as the APR) which is relevant to loan and other types of credit products.
What is an APR?
APR gives a consumer an accurate method for comparing savings accounts based on the amount of interest you will earn. In most cases, the APR will be applied to the daily balance of a savings account and then paid into the account as a lump sum the following month. In some cases, such as with a term deposit, the frequency of interest payments will affect the APR. You can choose to have monthly interest payments, but that could decrease the APR, plus in all likelihood those payments will be made into a separate account so that you do not earn compound interest.
Knowing the APR being offered by a bank for investing in their saving products is one of the easiest ways to determine where your money will get the most benefit, but it is not the only feature you should be looking into.
How does an APR work?
When you are comparing savings accounts in Australia, one of the biggest factors you are looking at is the percentage of interest your money will be earning. This number can vary from bank to bank, and also on the type of account you are interested in. Online savings accounts for example may offer a higher APR, but will limit your access to your money while a bonus account will increase it, but only if you are able to meet their terms.
CASE STUDY: JOHN WANTS TO FIND THE HIGHEST APR
John is looking for a way to save some money passively via finder.com.au. With no set goal in mind, he wants a savings plan that provides him with access to his money when he needs it. As he examines the features of two accounts offered by different Australian banks he notes that while one is offering a higher interest rate on his deposits with an online account, there are also transaction fees if he were to make any withdrawals and interest payments are made twice a year. With the second option, the interest rate is slightly lower, but allows for more fee free transactions and the payments are made monthly, making it a more cost effective choice in his circumstance.
While APR is an important feature in a savings account, it is not the only one to consider. Monthly and transaction fees, access methods and the way in which interest is calculated and frequency it is paid should also help determine which savings account provides you with the most financial benefit.
APRs in Australia
In Australia, banks keep it simple by simply referring to the percentage of money you earn as the interest rate. They will disclose this amount freely, and also provide you with any information that could affect the amount of interest earned by you.
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What’s the difference between APR and APY?
If in John’s example above, if he were to invest $100 in an account with an APR of 10%, he will have earned $10 by the end of the year. Yet since he did his comparisons, he chose an account that pays interest monthly, increasing his balance slightly each time. Now when the interest is calculated the next month, it is also slightly higher based on the new balance. This compounding of interest is what is also referred to as annual percentage yield (APY). The major difference between APR and APY in regards to savings accounts is that the APY also takes into consideration the compounding of interest which will take place during the year, while the APR is only the base rate.
What does yield mean in relation to APR?
In savings accounts where the interest payments are made into the account, you will be earning interest on the interest that has already been earned. This is compound interest and will increase the amount of money you earn overall with the account. The term yield is referring to this total amount of money that you increase your account by due to the APR. Other factors will of course also affect the yield on your savings account, such as the number of additional deposits, any withdrawals, and the fees that you might have to pay in order to access your money.