APR and APY both describe interest rates as a single annual percentage, which is exactly why people mix them up. The difference matters more than the labels suggest: one ignores compounding, the other accounts for it. When you are comparing a credit card to a mortgage, or a CD to a high-yield savings account, knowing which one you are looking at is the difference between a useful comparison and a misleading one.
Key Takeaways
- APR (Annual Percentage Rate) is the stated annual interest rate before any compounding effects. Used mainly for loans.
- APY (Annual Percentage Yield) is the effective annual rate after compounding is applied. Used mainly for deposits and savings.
- Higher compounding frequency makes APY higher than APR, but the gap is usually smaller than people expect.
- For loans, APR also typically includes certain fees; for savings, APY only reflects interest compounding.
- Always compare like with like: APR to APR for borrowing, APY to APY for saving.
What APR Actually Measures
APR is the annualized interest rate as it would apply with no compounding. If a credit card has a 24% APR with monthly compounding, the bank is charging 24/12 = 2% per month, not 2% in a way that compounds back into a 24% true annual cost.
In the United States, the Truth in Lending Act (TILA) requires lenders to disclose APR on most consumer credit products. The APR is intended to make loans comparable, and it usually includes:
- The base interest rate
- Most origination fees
- Mortgage points (where applicable)
- Some closing costs
But APR does not typically include:
- Late fees or penalty charges
- Application fees on some products
- The full impact of compounding
This is why a credit card with a 22% APR can effectively cost more than 22% if you carry a balance: the daily compounding produces a higher true cost (the APY equivalent).
What APY Actually Measures
APY is the effective annual rate after compounding is baked in. The formula is:
APY = (1 + r/n)^n − 1
Where r is the nominal annual rate (the APR-equivalent) and n is the number of compounding periods per year.
A 5% nominal rate compounded:
- Annually: APY = 5.00%
- Quarterly: APY = 5.09%
- Monthly: APY = 5.12%
- Daily: APY = 5.13%
- Continuously: APY ≈ 5.13%
APY is required disclosure for U.S. deposit accounts under the Truth in Savings Act. Banks must publish it on savings accounts, money markets, and CDs so consumers can compare yield on equal footing.
Side-by-Side Comparison
| Feature | APR | APY |
|---|---|---|
| Full name | Annual Percentage Rate | Annual Percentage Yield |
| Accounts for compounding? | No | Yes |
| Includes fees? | Often yes (loans) | No |
| Where you see it | Credit cards, mortgages, auto loans | Savings, money markets, CDs |
| Higher number favors | Borrower (lower is better) | Saver (higher is better) |
| Regulated by (US) | Truth in Lending Act | Truth in Savings Act |
Worked Example: Same Rate, Different Numbers
A bank offers a savings account at 5.0% APR compounded daily. The headline APY is:
APY = (1 + 0.05/365)^365 − 1 ≈ 5.127%
You deposit $10,000 and leave it untouched for one year. Your interest earned is approximately $10,000 × 0.05127 = $512.74, not $500. The 12.74 difference is compounding.
Now flip it. A credit card has a 19.99% APR compounded daily. Effective APY:
APY = (1 + 0.1999/365)^365 − 1 ≈ 22.12%
If you carry a $5,000 balance for a full year without payments, you owe roughly $1,106 in interest, not $999. That gap is what makes credit card debt grow faster than the rate alone suggests.
When Each One Is the Right Lens
Use APR when:
- Comparing two loans of the same length with similar fee structures
- Reading the disclosure on a mortgage or auto loan
- Looking at the rate inside an amortization schedule (where interest accrues per period)
Use APY when:
- Comparing savings accounts, CDs, or money market funds
- Calculating actual annual return on a deposit
- Modeling long-term compound growth
If a product gives you APR but you want to compare across compounding frequencies, convert to APY using the formula above. Most online calculators do this automatically.
Common Mistakes
Comparing APR on a loan to APY on a deposit. They are not directly comparable. Convert one or the other first.
Assuming APR includes all loan costs. It includes most fees but not late charges, prepayment penalties, or insurance. Read the disclosure carefully.
Thinking daily compounding will dramatically beat monthly. On a 5% rate, the gap is about 0.01 percentage points. Time and rate matter much more than frequency.
Treating APY on a promotional account as permanent. Many high-APY savings accounts run promotional rates that step down after 3–6 months. Always check the standard rate.
Forgetting APR-to-APY converts both directions. A credit card with a 22% APR has a higher effective cost (APY ≈ 24.6% with daily compounding). The same logic that boosts your savings boosts your debt.
Practical Scenarios
Choosing a savings account. Two banks advertise "5.0%." Bank A says 5.0% APR with monthly compounding. Bank B says 5.0% APY. Bank B is the better headline, since they have already stated the post-compounding number. Bank A's effective yield is 5.12%, which slightly beats Bank B unless Bank B's APY came from a higher APR.
Refinancing a mortgage. A new lender offers a 6.5% APR with $4,000 in closing costs, versus your current 6.8% APR. The new APR already includes the closing costs amortized over the loan term, which is why APR is the standard comparison number for mortgages, not the note rate.
Comparing credit cards. Card A has 18% APR with daily compounding. Card B has 19% APR with monthly compounding. Card A's APY is about 19.72%; Card B's is about 20.75%. Card A is the cheaper carry despite the lower headline difference suggesting they are close.
FAQ
Is APR or APY always higher? APY is always equal to or higher than APR, because APY includes compounding. The two are equal only when there is no compounding (annual compounding with no fees).
Why do credit cards advertise APR, not APY? Disclosure law requires it. The Truth in Lending Act mandates APR as the standard rate disclosure for most consumer credit. The effective APY is usually higher due to daily compounding.
Why do savings accounts advertise APY, not APR? The Truth in Savings Act requires APY disclosure on deposit accounts so consumers can compare actual yield. Banks generally show the more attractive number anyway.
Can APR be lower than the interest rate? Rarely. APR can be lower than the contract interest rate if certain rebates or credits are factored in, but in most loans APR is equal to or slightly higher than the note rate because it folds in fees.
Does APY include fees? No. APY only reflects compounding of interest. Bank fees, withdrawal penalties, and account maintenance charges reduce real yield separately.
How do I convert APR to APY? APY = (1 + APR/n)^n − 1, where n is the number of compounding periods per year. For monthly compounding at 6% APR: (1 + 0.06/12)^12 − 1 ≈ 6.17% APY.
Which one should I focus on when shopping? Use APR for loans and APY for savings; that is the regulated convention. If you need to compare across products, convert both to APY.
Related Tools
Run scenarios with the Compound Interest Calculator to see the APR-to-APY gap at different rates, or use the Loan Calculator to compare loan APRs side by side. For deposit comparisons, the Savings Calculator models APY growth over time, and the Mortgage Calculator shows how APR translates into a monthly payment.
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Final Thoughts
APR and APY answer different questions. APR is "what is the contractual rate?" APY is "what is the effective rate after compounding?" Lenders and banks use whichever number makes their product look more competitive, which is why disclosure law forces specific terms in specific contexts. Learn to convert between the two and the marketing language stops mattering: you can compare any rate to any other rate on equal footing.
The simplest habit: when you see a rate, ask which one it is, and convert to APY for apples-to-apples comparison.