APR vs APY distinction

What is APR and what is APY?

     APR is Annual Percentage Rate and is essentially your interest rate that you pay per year on principal. APY is Annual Percentage Yield and essentially takes into account the compounding of the interest based in lender specified time period.

What is more important when looking for the loan?

     APY will definitely give you a much more accurate picture of how much money in total interest you are going to pay over the life of the loan. Essentially, many companies use APR in advertising, because it is the lower number, and they often put compounding terms somewhere in small letters. Many banks that provide investment options usually list APY to make it more attractive.

APY is calculated using the following formula:

     Annual interest rate divided by the number of times it'll compound per year (r/n), gives us periodic rate, therefore:

     APY = (1 + r/n )ⁿ – 1

r is an annual interest rate and n is the number of times it'll compound per year. Based on this APY formula you can calculate your true costs of any car loan.

Example:

     Suppose you want to take out a car loan, you have two alternatives, one is 10,000$ with 8% APR, that is being compounded quarterly, another one is for 10,000$ with 7.89% APR that is being compounded daily, which one would you choose?

First loan for 10,000$ with 8% APR compounded quarterly:

APY = (1 + 0.08/4)^4 - 1 = .082
in other words, it will yield APY of 8.2%

The second loan for 10,000$ with 7.89% APR compounded daily:

APY = (1 + 0.0789/365)^365 - 1 = .082
in other words, it will yield APY of 8.2%

     As you can see, the APY is the same, so essentially two different advertised APR's yield essentially the same overall cost. However, pay close attention to any fees the lending institution might apply and take those into consideration when shopping for a loan. If any extra fees are less on 8% loan that is being compounded quarterly, then it makes total sense to get 8% that is compounded quarterly, over 7.89% that is being compounded daily.

Conclusion:

     When comparing car loans, choose the lowest APY.