APR vs. APY: What’s the difference?

The terms “APR” and “APY” are easily confused. They sound similar, and both refer to interest rates. But there are significant differences between APR vs. APY — most importantly, APY includes the effects of compound interest, while APR doesn’t.

Generally speaking, APR is typically used in the context of borrowing to describe the interest rates charged on things like credit cards and mortgages. APY is more commonly used to refer to the interest rates earned on things like investments and savings accounts.

APR vs. APY: The basics

APR stands for "annual percentage rate." APY stands for "annual percentage yield."

Both APR and APY refer to interest rates, but the specifics of the terms differ significantly.

Perhaps the biggest difference is that APR is typically used to reference interest rates on loans and credit cards — meaning APR is usually interest that you pay.

On the other hand, APY is primarily used for interest on savings accounts and other financial products. So APY is more often used for interest you earn.

Another key difference is that APR doesn’t reflect compound interest (more on this below), while APY does. APR also reflects fees, while APY doesn’t.

APY accurately reflects the profits you can earn from depositing money in a given account for 1 year. And APR mostly reflects the cost of borrowing money for 1 year — although there’s a tricky catch due to APR’s exclusion of compounding interest.

Consider these two examples:

• You make a $100 deposit into a savings account earning 1.00% APY. If you wait 1 year, you’ll earn $1 in interest (1% of $100).
• You make a $100 purchase on credit with a 12.00% APR — equal to a monthly rate of 1% per month. If you pay the purchase off 1 month later, you’ll pay $1 in interest total (1% of $100). If you wait 1 year, you’ll actually pay more like 12.68% (or $12.68 in interest) due to the effects of compounding interest.

Both APR and APY are useful for estimating the costs — or profits — of a given loan or savings product. They’re also useful for comparing multiple options to find the best deal for your situation.

Put simply, a savings account with a higher APY will earn you more interest. And a loan with a lower APR will charge you less interest.

Because APR and APY are standardized, these stats make it simple to compare multiple options. When shopping for a loan, you can compare APR across multiple different products. When shopping for a new savings account or financial product, you can compare APY.

Understanding compound interest

A key difference between APR vs. APY is in how interest is computed. Specifically, it’s a difference in how interest is measured for compounding interest.

Compound interest is essentially the interest earned (or accrued) on the interest you’ve already earned.

For example, if you deposit $100 at 5.00% interest, you’ll have $105 after 1 year. After 2 years, you’ll have $110.25. In this case, the $5 in interest that you earned in year 1 generated an additional $0.25 in interest for you in year 2.

Compounding interest can create a “snowball” effect, where savings grow faster and faster over time. This is particularly true over long periods of time.

But compounding also applies to debt. For instance, if you take out a loan for $100 at 10.00% interest, the year 1 interest charge would be $10 — resulting in an end balance of $110 (assuming you make no payments). After 2 years, the interest charge would be $11, resulting in an end balance of $121.

Note: This is a simplified example that assumes interest is compounded yearly, which is uncommon. Interest typically is compounded monthly or even daily. This also assumes that no payments are made, which is uncommon.

APY includes compounding interest

Annual percentage yield (APY) already takes into account the effect of compounding interest. This means it’s an accurate measure of how much interest you’ll earn after 1 year.

$100 deposited for 1 year at 6.00% APY will earn exactly $6 in interest.

APR doesn’t include compounding interest

Annual percentage rate (APR) does not take into account the effect of compounding interest. This means it’s a less accurate measure of the amount of interest charged after 1 year.

$100 loaned out for 1 year at 6.00% APR will actually result in a bit more than $6 in interest. If the interest compounds monthly, it'll cost $6.17 in interest. In this case, the APR is 6.00%, but the equivalent APY is 6.17%.

Compound interest can work for you — or against you

When it comes to your savings and investments, compounding interest is great news. It means your money will grow faster and faster over time.

When it comes to loans and credit cards, however, it means you’ll pay a bit more than the listed APR. This is because the interest charges can be added to your balance, resulting in a higher balance and more interest charges in subsequent months.

What is APR (annual percentage rate)?

APR stands for annual percentage rate. Expressed as a percentage, it refers to the amount of interest in a 1-year period.

In most cases, APR is used to refer to interest rates on loans and credit cards. Therefore, it’s usually used to refer to the cost of borrowing money.

You may see a credit card with a 20.00% APR, a personal loan with a 12.00% APR, or student loans with a 6.00% APR.

APR accounts for the interest charges and associated fees. It’s a relatively accurate measure of the cost of borrowing money. However, it doesn’t account for compounding interest.

APR can be used to compare multiple options when it comes to loans and credit cards. It can also be used to estimate the interest costs of a given purchase after 1 year.

What is APR used for?

APR is mostly used for indicating the cost of borrowing money. APR will be listed for auto loans, mortgages, credit cards, and other financial products.

In most cases, APR is used for the interest rate you'll pay rather than what you'll earn on something like a savings account. APY is more commonly used for savings products and investments.

APR can be useful for estimating borrowing costs and for comparing multiple options. If you have the option between a loan at 9.00% APR and a loan at 11.00% APR, it’s clear that the 9.00% APR is a better option.

How is APR calculated?

APR is calculated by taking the periodic interest rate and multiplying it by the number of periods in a year in which interest is applied. In most cases, interest accrues daily, so the number of periods is 365.

It’s not usually necessary for individuals to know how to calculate APR. Lenders are required to list APR on their loan products, so all consumers need to do is compare different options.

Types of APRs

There are a few different types of APRs.

Fixed APR: A fixed APR means that the APR won't change over the life of the loan. This is common in mortgages and other large loans.

Variable APR: A variable APR means that the APR can change with market conditions. If interest rates rise, the APR will likely also rise. This is common in forms of revolving credit, like credit cards and lines of credit.

Purchase APR: Purchase APR applies to purchases made on a credit card. This is the standard APR when it comes to credit cards.

Cash advance APR: Cash advance APR applies when you take a cash advance from a credit card. It’s usually a separate (higher) APR than for purchases.

Balance transfer APR: Balance transfer APR applies when you transfer a credit card balance from one card to another.

Introductory APR: Introductory APR applies when a credit card issuer offers a promotional introductory period. Some issuers offer a period of 0% APR on purchases and balance transfers — often for the first 6–12 months of card membership.

What is APY (annual percentage yield)?

APY stands for annual percentage yield. It indicates the interest rate earned on savings accounts and certain types of investment products.

APY is an accurate measure of how much a particular account will earn in interest over a 1-year period. An account offering 1.00% APY will earn exactly 1.00% in interest. If you were to deposit $100 in this account for 1 year, you would earn $1 in interest.

APY accounts for the effects of compounding interest. This is discussed in more detail in the compounding interest section above.

What is APY used for?

APY is primarily used to list the daily compounding interest rate on savings accounts and other financial products.

Checking and savings accounts, certificates of deposit (CDs), and high-yield savings accounts will all use APY to list the amount of daily compounding interest they pay.

APY is also sometimes used for other investments, although it’s typically only relevant when there’s a fixed yield.

For example, APY isn’t typically used on investments like stocks because stocks don’t offer a fixed rate of return. You could calculate the historical APY of a given stock, but there’s no way to predict the return going forward.

How is APY calculated?

APY is calculated using the following formula.

Of course, it’s much simpler to use an online calculator. This APY calculator allows you to make quick calculations using either APY or simple interest.

Example of APY

APY is listed on products like savings accounts.

For example, you might see a savings account offering 0.25% APY. This means depositing money for 1 year would earn 0.25% interest — or $0.25 on a $100 deposit.

Another high-yield account may offer 1.50% APY. This means you’d earn $1.50 on a $100 deposit after 1 year.

APR vs. APY for borrowers

When borrowing money, you’ll most likely be presented with many options. Each will list the stated APR.

APR is a fairly accurate measure of the cost of borrowing money, but it’s actually a bit lower than the true cost. This is because APR doesn’t account for compounding interest.

With a loan, the interest charges are added to the balance, which increases the loan balance. This, in turn, increases the future interest charges.

The result is that the true cost of borrowing will be slightly higher than the listed APR.

Assuming that interest is compounded monthly, here’s the true cost of borrowing for various listed APRs:

• 5.00% APR becomes 5.11% with monthly compounding
• 9.00% APR becomes 9.38% with monthly compounding
• 20.00% APR becomes 21.94% with monthly compounding

While a loan may quote an APR of 9.00%, you’ll actually pay 0.38% more than that. That might not seem like much, but it can really add up over time.

The higher the initial APR and the more often the interest compounds, the more of a difference there will be between the listed APR and the true cost of borrowing.

It’s important to consider this difference when shopping for a loan. It’s also important to make sure you’re comparing options with an even playing field. For instance, a 10.00% APR loan with daily compounding will be more costly than a 10.00% loan with monthly compounding. You may need to read the fine print or contact the lender to learn the details.

APR vs. APY for lenders

Lenders are required to list certain figures on their financial products. However, financial institutions are allowed to use APR for loans and APY for savings products.

Both are in the best interest of the lending financial institution.

Using APR makes loans seem slightly cheaper than they actually are. Since APR ignores compounding interest, the true cost of borrowing will be slightly higher than the listed APR.

And using APY makes savings products seem more attractive (as compared to using an APR). APY is at least fully transparent, as it does accurately represent the amount of interest you'll earn in a year.

Bottom line

Annual percentage rate, or APR, refers to simple interest that does not take into account compounding interest. It’s primarily used to describe interest rates on loans and credit cards.

Annual percentage yield, or APY, refers to the interest rate that does account for compounding interest. It’s generally used to describe the yield on savings accounts or CDs.