APR vs. APY: Why the Difference Matters

APR and APY look almost identical but answer opposite questions. APR (annual percentage rate) is what borrowing costs you; APY (annual percentage yield) is what saving earns you. The difference between them is compounding — and knowing which is which keeps banks from quoting you the flattering number.

The core difference: compounding

APR is a simple annual rate that ignores compounding within the year. APY folds compounding in, so it reflects the true yearly figure once interest starts earning interest. Because compounding always helps, APY is equal to or higher than the nominal rate — which is exactly why banks advertise APY on savings and APR on loans.

On savings, compare APY

Two savings accounts quoting the same 5% can pay different amounts depending on how often they compound — daily beats monthly beats annually. APY captures that, so it's the honest way to compare accounts and CDs. Federal law (the Truth in Savings Act) requires banks to disclose APY for this reason; always compare deposit products on APY, not the stated rate.

On loans, compare APR

For borrowing, APR is the number to compare — but note that a loan's APR also rolls in certain fees and points, not just interest. That makes APR higher than the note rate and a fairer basis for comparing two mortgages or personal loans. The catch: a credit card's APR ignores the effect of monthly compounding, so the rate your balance actually grows at (the effective APY) is a bit higher than the quoted APR.

What compounding frequency is worth

Take a 5% nominal rate and vary only how often it compounds:

• Compounded annually — APY 5.000%.
• Compounded monthly — APY 5.116%.
• Compounded daily — APY 5.127%.

The gap between annual and daily is about 0.13 percentage points, which on a $20,000 balance is roughly $25 a year. Real, worth having, and much smaller than the difference between a competitive account and a poor one — so compare on APY, but do not agonise over compounding frequency when the headline rates differ by whole points.

Where the gap actually bites: credit cards

The same effect runs the other way on debt, and there it is not small. A card advertising 22.99% APR typically compounds daily, which makes the effective annual rate about 25.84%.

On a $5,000 balance carried for a year, that is roughly $1,292 of interest rather than the $1,150 the quoted APR implies — about $142 that the headline number does not mention. The quoted APR on a card is the one figure in consumer finance that systematically understates what you will pay.

Where APR misleads on a mortgage

A mortgage APR spreads the loan's fees and points across the full term, which makes it an excellent comparison tool for a loan you will hold to maturity and a poor one for a loan you will not.

Most borrowers sell or refinance long before thirty years. Paying $6,000 in points lowers the APR because the saving is amortised over the whole term, but if you move after six years you have paid the points and captured only a fraction of the benefit. Two quotes with the same APR can therefore have very different costs for you specifically, depending on how long you keep the loan.

The fix is to compare total cost over your realistic holding period rather than APR over the lender's assumed one.

The “0% APR” that is not

Retail financing advertised as 0% comes in two forms that behave completely differently. A genuine promotional rate charges nothing during the period, and any remaining balance simply begins accruing afterwards.

Deferred interest is the other kind. Interest accrues invisibly from the day of purchase and is waived only if the entire balance is cleared before the deadline. Miss it by a month, or by a few dollars, and the whole accumulated amount is added at once, calculated on the original purchase price. The advertised rate is the same; the outcome is not. The distinction is in the terms, and it is worth finding before signing rather than after.

The asymmetry to remember

Each disclosure regime forces the more informative number in its own direction, and the result is a useful asymmetry:

• On savings, APY is required and includes compounding — so the advertised figure is the honest one, and comparing two accounts on APY is straightforward.
• On loans, APR is required and includes fees and points — so it is more honest than a quoted note rate, but it still excludes intra-year compounding.

So the practical rule is not simply “compare APY to APY”. It is: on deposits, trust the APY; on instalment loans, compare APR because it captures the fees; and on revolving credit, remember that the true cost sits above the APR you were quoted.

Run your own number

Convert any nominal rate and compounding frequency into a true yield in the APY calculator, and see how fees push a note rate up to its real cost in the APR calculator. Then apply it where it matters: compare deposit accounts in the savings calculator, and see what the effective rate is doing to a balance in the credit card payoff calculator.