APR vs. APY: What's the Difference and When Each Is Used

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APR (annual percentage rate) and APY (annual percentage yield) both describe interest over a year, but they measure different things. APR is a yearly rate that, on loans, folds in certain fees but does not include compounding. APY does include compounding: it shows the total return a deposit earns over a year when interest is added to the balance and then earns interest itself. Lenders quote APR on mortgages, auto loans, personal loans and credit cards. Banks quote APY on savings accounts, money market accounts and certificates of deposit (CDs).

The basics: nominal rate, APR and APY

Three numbers often appear on the same product, and they build on each other.

Nominal (stated) interest rate. The base rate applied to your balance, with no fees and no compounding. A savings account paying “5% p.a.” (per annum) is stating a nominal rate.

APR. For a loan, APR starts with the interest rate and adds certain finance charges, then expresses the total as a yearly percentage. On a mortgage, that can include discount points (an upfront fee paid to lower the rate), mortgage broker fees and other loan-related charges. Because of those fees, a loan’s APR is usually equal to or higher than its interest rate. On most credit cards the APR and the interest rate are effectively the same number, and a card can carry several APRs at once: purchase, balance transfer, cash advance, penalty and introductory rates. The gap between a loan’s rate and its APR has its own explainer: interest rate vs. APR.

APY. For a deposit, APY takes the nominal rate and adds the effect of compounding over one year. It is the same idea as the effective annual rate (EAR). In the UK the equivalent figure is the AER (annual equivalent rate). All three answer the same question: what percentage does a balance actually grow by in a year?

How it works: the formulas

APR

At its simplest, APR is the periodic rate times the number of periods per year:

APR = periodic rate × periods per year

A credit card charging a 2% monthly periodic rate has an APR of 2% × 12 = 24%. A card with a daily periodic rate of 0.0657% has an APR of about 24% (0.0657% × 365).

For an installment loan, the full Regulation Z calculation solves for the rate that equates the amount you actually receive (the loan minus prepaid finance charges) with the payment schedule. A rough approximation for a single-payment loan:

APR ≈ [(fees + interest) ÷ principal ÷ days in term] × 365 × 100

APY

APY = (1 + r ÷ n)ⁿ − 1

• r = nominal annual rate as a decimal
• n = number of compounding periods per year

Add the periodic rate (r ÷ n) to 1, raise the result to the number of periods, then subtract 1.

The Truth in Savings regulation (Regulation DD) uses an equivalent form based on actual interest earned: APY = 100 × [(1 + interest ÷ principal)^(365 ÷ days in term) − 1].

Converting between them

• APR to APY: use the APY formula above.
• APY to APR: APR = n × [(1 + APY)^(1/n) − 1]

Example: a 5.116% APY compounded monthly converts back to 12 × [(1.05116)^(1/12) − 1] ≈ 5.00% APR.

Examples

Example 1: same rate, different compounding

These hypothetical rates show what one nominal rate amounts to over a year at different compounding frequencies.

At low rates the difference is a fraction of a point. At credit card levels it reaches roughly three points: a 24% APR compounded daily works out to about a 27.11% effective rate on a balance that is carried, unpaid, for a full year.

Example 2: a $5,000 loan vs. a $5,000 CD

Assumptions: both use a 5% nominal rate compounded monthly over 12 months.

Loan. You borrow $5,000 at 5% APR and repay it in 12 equal monthly payments of about $428.04. Total repaid is about $5,136.45, so interest is $136.45.

CD. You deposit $5,000 in a 12-month CD at a 5% rate compounded monthly. The APY is (1 + 0.05/12)¹² − 1 ≈ 5.116%. With no withdrawals, the CD earns about $255.81.

Same rate, nearly double the dollars. The difference has nothing to do with APR versus APY as labels. Each loan payment reduces the principal, so interest is charged on a shrinking balance. The CD’s balance never shrinks; it grows every month. An amortization schedule shows exactly how each loan payment splits between principal and interest.

Example 3: how fees push APR above the interest rate

Hypothetical one-year, single-payment loan: $10,000 at a 6% interest rate, with a $200 origination fee deducted from the proceeds.

• You receive $9,800.
• At the end of the year you repay $10,600 ($10,000 principal plus $600 interest).
• Total finance charge: $600 interest + $200 fee = $800.
• APR ≈ $800 ÷ $9,800 ≈ 8.16%.

The quoted interest rate is 6%, but the cost of the money you actually received is about 8.16% a year. This is why APR is the better comparison number for loans with different fee structures.

When to use APR vs. APY

Use APR when you borrow. Comparing mortgages, auto loans, personal loans or credit cards, line up the APRs. A lower APR means a lower annual cost, fees included. Remember that APR leaves out compounding, so on a revolving balance such as a credit card the effective cost of carrying debt is higher than the APR (see the 24% row above). If your card has a grace period and you pay the full statement balance by the due date, purchase interest generally is not charged at all.

Use APY when you save. Comparing savings accounts, money market accounts or CDs, line up the APYs. A higher APY means more growth, and because APY already reflects compounding frequency, you do not need to adjust for whether one bank compounds daily and another monthly.

Converting for a fair comparison. If one offer shows a nominal rate and another shows APY, convert the nominal rate to APY (or the APY back to a nominal rate at the same compounding frequency) before deciding. To estimate loan interest in dollars rather than percentages, see how to calculate principal and interest.

Special considerations

What APY leaves out

APY assumes the full balance stays in the account for a year at the stated rate. Several things can make your actual earnings differ:

• Withdrawals. Taking money out, or taking interest out instead of letting it compound, reduces what you earn. For a CD, early withdrawal penalties can cut into earnings further.
• Variable rates. On most savings and money market accounts the rate can change at any time, so the APY is a snapshot, not a promise. A CD’s APY is typically fixed for the term.
• Tiered rates. Some accounts pay different APYs on different balance ranges. Special disclosure rules apply to tiered and variable accounts.
• Bonuses and fees. APY does not include sign-up bonuses, and a monthly maintenance fee is not deducted from it. A $5 monthly fee on a small balance can erase the interest entirely.
• Inflation and taxes. APY is a nominal return. Growth in purchasing power depends on how it compares with the inflation rate, and interest is generally taxable.

What APR leaves out

APR does not capture compounding on unpaid balances, and it does not include every cost. On a mortgage, some closing costs fall outside the finance charge. APR on an adjustable-rate loan is based on assumptions about future rates. On a credit card, a promotional APR ends, and a penalty APR can apply after a late payment.

How much do small differences matter?

Work it out in dollars. On a hypothetical $10,000 deposit, a 4.00% APY earns $400 in a year and a 3.75% APY earns $375: a $25 difference. On a hypothetical $5,000 credit card balance carried for a year, the difference between a 23% and a 25% APR is roughly $100 in interest before compounding. Whether that matters depends on the balance, the time you hold it and the other terms of each account.

What counts as a good APR?

For borrowing, lower is better, and the rate you are offered depends heavily on your credit score, income, the loan type and the term. Compare like with like: mortgage APRs with other mortgages of the same term, rewards card APRs with other rewards cards. The Federal Reserve publishes average rates on consumer credit products such as new car loans, personal loans and credit cards, which can serve as a benchmark.

The Bottom Line

Anyone comparing a loan, credit card, savings account or CD needs to match the right number to the product: APR for borrowing, APY for saving. Line up offers on the same measure, converting a nominal rate to APY when needed, and check the costs each figure leaves out, such as fees, withdrawals, variable rates and compounding on carried balances. Working the difference out in dollars shows whether a gap between two offers actually matters.