APR vs APY: What's the Difference?
APR (Annual Percentage Rate) and APY (Annual Percentage Yield) both describe interest rates, but they measure different things. APR is the nominal annual rate without accounting for compounding within the year. APY — also called EAR (Effective Annual Rate) — includes the effect of compounding and shows the true annual return or cost.
The difference matters because most interest in the real world compounds more often than once per year: savings accounts compound daily, mortgages compound monthly, credit cards compound daily. APY captures this compounding and tells you what you actually earn (or pay) per year. Understanding both is essential for comparing financial products that use different compounding frequencies.
APR: What It Is and What It Misses
APR is the stated annual interest rate without factoring in compounding within the year. If a credit card charges 1.5% per month, its APR is 1.5% × 12 = 18% — a simple multiplication. But the actual annual cost is higher because each month's interest is added to the balance before the next month's interest is calculated. The 18% APR credit card actually costs 19.56% per year (the APY).
US federal law (the Truth in Lending Act) requires lenders to disclose APR prominently for loans and credit cards. This makes APR a standardized, comparable number across products — but it understates the true cost by ignoring intra-year compounding. For mortgages, APR also includes origination fees and closing costs spread over the loan term, which makes mortgage APR a better cost comparison than the stated interest rate alone.
APR to APY Conversion Formula
APY = (1 + APR/n)ⁿ − 1 where n = number of compounding periods per year Examples (18% APR): Annually (n=1): APY = (1 + 0.18/1)¹ − 1 = 18.00% Monthly (n=12): APY = (1 + 0.18/12)¹² − 1 = 19.56% Daily (n=365): APY = (1 + 0.18/365)³⁶⁵ − 1 = 19.72% For savings: 5% APR compounded daily: APY = (1 + 0.05/365)³⁶⁵ − 1 = 5.127% Continuous compounding limit: APY = e^APR − 1 = e^0.05 − 1 = 5.127% (same as daily at this rate)
APY: The True Return (or True Cost)
APY tells you what you actually earn in a year, accounting for compounding. The US Truth in Savings Act requires banks to disclose APY for deposit accounts. When comparing savings accounts, money market accounts, or CDs, always compare APY — a 4.9% APR account compounding monthly actually delivers 5.01% APY, while a 5.0% APR account compounding quarterly delivers only 5.09% APY. The compounding frequency matters.
For savings, higher APY is better. For debt, lower APY (true effective rate) is better — though for loans the term 'APY' is rarely used; look at EAR or the total cost of credit instead. Credit card companies disclose APR; to find the true annual cost, use the formula: APY = (1 + APR/365)³⁶⁵ − 1. An 18% APR credit card with daily compounding has an APY of 19.72%.
When to Use APR vs APY
Use APR for comparing: loan offers (mortgages, auto loans, personal loans — APR includes fees, enabling apples-to-apples comparison). Credit card offers. Any borrowing product where the law requires APR disclosure. Use APY for comparing: savings accounts, money market accounts, CDs, and any deposit product. Investment returns expressed annually (equities, funds).
For credit cards specifically: APR is the legal disclosure, but since cards compound daily, the true cost is APY ≈ APR + ~1.5–2% (at 18–24% APR). When comparing cards, use APR as a proxy — since compounding frequency is always daily for cards, the APR ranking and APY ranking will be the same. The absolute cost is ~1.5–2% higher than the disclosed APR.
Frequently Asked Questions
Why does my savings account show APY instead of APR?
US law (Truth in Savings Act) requires banks to advertise deposit accounts using APY because it shows the true annual yield after compounding. APY is better for savers because it reveals what you actually earn. If a bank advertised APR, the actual return would be slightly higher, making it appear the bank is being deceptive — APY avoids this.
If APR and APY are similar numbers, does it really matter?
At low rates (1–5%), the difference is small: a 5% APR compounded monthly yields 5.116% APY — barely noticeable. At high credit card rates (20–25%), the gap is 1.5–2% annually. On a $10,000 balance, that is $150–200 of additional cost per year. Over years of carrying a balance, the compounding effect compounds the compounding effect.
What does 'compounded daily' mean?
Your interest is calculated and added to the balance every day, not just once a year. Each day's interest is 1/365 of the annual rate applied to the current balance (including previous days' interest). This means you earn (or owe) interest on your interest, starting immediately. Daily compounding gives the highest APY for a given APR — slightly more than monthly compounding.
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