APR vs APY: What Is the Difference?

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APR (Annual Percentage Rate) and APY (Annual Percentage Yield) sound similar but have a critical difference: compounding. APR is the simple annual rate, while APY includes the effect of compounding interest. Understanding this difference can save or earn you hundreds of dollars.

What Is APR?

APR is the annual cost of borrowing money, expressed as a percentage. It includes the interest rate plus certain fees, but does not account for compounding. APR is used for credit cards, auto loans, personal loans, and mortgages.

For example, a credit card with a 22% APR charges you 22% of your balance per year. If you carry a $1,000 balance for a full year, you pay approximately $220 in interest (simplified — actual interest is calculated daily).

What Is APY?

APY is the effective annual return on an investment or savings account, including the effect of compounding interest. APY is used for savings accounts, CDs, and investment returns.

For example, a savings account with a 5% interest rate compounded monthly has an APY of 5.12%. The extra 0.12% comes from earning interest on your interest throughout the year.

The Compounding Effect

The formula connecting APR and APY is: APY = (1 + APR/n)^n - 1, where n is the number of compounding periods per year. The more frequently interest compounds, the bigger the gap between APR and APY.

Annual compounding (n=1): APR and APY are identical
Monthly compounding (n=12): APY is slightly higher than APR
Daily compounding (n=365): APY exceeds APR by about 0.05% at typical rates
Continuous compounding: APY is maximized at APR = r, APY = e^r - 1

Why It Matters for Your Money

When you borrow, lenders advertise APR because it looks lower. When you save, banks advertise APY because it looks higher. Always compare apples to apples. A 22% APR credit card with daily compounding effectively charges 24.6% APY.

For savings, always look at APY — it tells you exactly what you will earn. For loans, APR is the standard, but be aware that the true cost may be higher due to compounding.

Real-World Examples

Here are common financial products and how APR vs APY applies:

Credit card: 22% APR = 24.6% APY (daily compounding)
Savings account: 4.5% APY (already includes monthly compounding)
Mortgage: 6.5% APR (amortized, compounding built into payment schedule)
Payday loan: 400% APR (compounding makes effective rate astronomical)
Investment return: Quoted as APY when including dividends and growth

Frequently Asked Questions

Is APR or APY better?

For borrowing, APR is better because it is lower. For saving, APY is better because it is higher. They measure the same underlying rate but APY includes compounding.

Can APR and APY be the same?

Yes, when interest compounds annually (once per year). In that case, there is no difference between APR and APY.

Why do credit cards use APR?

APR makes borrowing costs appear lower, which is favorable to lenders. APY would show the true cost of daily compounding, which is higher and would discourage borrowing.