APR vs. APY: The Two Percentages That Run Your Money

APR and APY show up on almost every financial product, and they look like the same thing. They are not the same thing, and the difference between them is compound interest. Knowing which number you are looking at tells you what you will actually earn or pay in a year.

The short version

APR (annual percentage rate) is the simple yearly rate without compounding, and on loans it also includes certain fees. APY (annual percentage yield) is what you actually earn or pay in a year once compounding is counted.

Compounding is interest earning interest. If interest gets added to your balance every month, next month's interest is calculated on a slightly bigger balance, and that difference is the gap between APR and APY.

Same rate, different results

Take 5% on $10,000. As a flat rate with no compounding, that is $500 in a year. Compounded monthly, each month's interest gets added to the balance before the next month is calculated, and the year ends around $512, which is an APY of about 5.12%. The gap looks small at these numbers, but it grows with the rate, with how often the compounding happens, and most of all with time.

Banks advertise whichever number looks better. Savings accounts get quoted in APY because compounding makes the number bigger, and loans get quoted in APR because the number looks smaller. Neither one is lying. You just have to know which number you are being shown.

Your savings

For savings accounts and CDs, compare APY to APY. The APY is the true yearly earn with compounding included, and it is the number the law requires banks to disclose. A high-yield savings account advertising 4.5% APY on $10,000 pays about $450 over a year.

One thing to know is that savings APYs are variable. The rate moves when the Fed moves, so the number you sign up at is not a promise. CDs lock their rate in, which is the main reason people buy them.

Your debt

Loans work in APR. For mortgages, the APR bundles certain fees in, which makes it useful for comparing lenders, because a loan with a lower rate but heavy fees can end up with the higher APR.

Credit cards are where the difference costs the most. A card with a 24% APR compounds daily when you carry a balance, and that works out to roughly 27% APY on the money you owe. The same compounding that grows savings also grows debt, and it is one more reason carrying a card balance is more expensive than the statement makes it look.

Which number to use

For money you are earning, look at the APY, and higher is better. If you are borrowing, use the APR to compare loans, and remember that the real cost runs a little above it once compounding is counted. The two abbreviations are one letter apart, but they answer different questions, so check which one you are reading before you compare anything.

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This article is for general educational purposes only and does not constitute personal financial, investment, tax, or legal advice. Consult a qualified financial professional before making major financial decisions. See our Disclaimer.