Understanding APR vs. APY: What Is the Difference?
Understand the difference between APR and APY. Learn how each rate is calculated, when each applies, and why APY always appears higher than APR.
APR Explained
Annual Percentage Rate (APR) represents the yearly cost of borrowing money, expressed as a percentage. It includes the base interest rate plus any mandatory fees (like origination fees) but does not account for the effect of compounding. APR is most commonly used for credit cards, mortgages, auto loans, and personal loans. Lenders are required by law (the Truth in Lending Act) to disclose the APR so borrowers can compare loan offers on a level playing field. A mortgage with a 6.0 percent interest rate but significant fees might have an APR of 6.25 percent, making it more expensive than it initially appears.
APY Explained
Annual Percentage Yield (APY) represents the total amount of interest you earn on a deposit account over one year, factoring in compound interest. Banks are required to disclose the APY on savings accounts, CDs, and other deposit products under the Truth in Savings Act. APY will always be equal to or higher than the stated interest rate because it includes the effect of compounding. A savings account with a 4.85 percent interest rate compounded daily has an APY of approximately 4.97 percent. The more frequently interest compounds (daily, monthly, quarterly), the higher the APY relative to the nominal rate.
The Math Behind the Difference
APY is calculated using the formula: APY = (1 + r/n)^n - 1, where r is the nominal annual interest rate and n is the number of compounding periods per year. For a 5 percent rate compounded monthly: APY = (1 + 0.05/12)^12 - 1 = 5.116 percent. Compounded daily: APY = (1 + 0.05/365)^365 - 1 = 5.127 percent. The difference grows larger with higher interest rates. At 10 percent compounded monthly, APY is 10.47 percent — nearly half a percentage point more. This is why APY is the better metric for comparing savings accounts, as it reflects what you actually earn.
Recommended Resources
Earn up to 5.00% APY with an online savings account.
Start investing with $0 commissions on stocks and ETFs.
Sponsored · We may earn a commission at no cost to you
When Each Rate Matters
When borrowing money, focus on APR — it represents your true cost of borrowing and includes fees. When saving or investing, focus on APY — it represents your true earnings including compound growth. Credit card APRs are particularly important because cards compound interest daily on unpaid balances, so the effective annual cost is higher than the stated APR. When comparing two savings accounts, always compare APYs, not stated interest rates, because different compounding frequencies can make a lower rate produce a higher yield. A 4.90 percent rate compounded daily actually earns more than a 4.95 percent rate compounded annually.
Related Free Tools
Related Articles
Frequently Asked Questions
Why is APY always higher than APR for the same rate?
APY includes the effect of compound interest — earning interest on previously earned interest — while APR does not. When interest compounds (daily, monthly, or quarterly), you earn slightly more each period because the base grows. This compounding effect means the actual annual yield exceeds the simple annual rate. The more frequent the compounding, the greater the difference.
Which rate should I compare when shopping for a mortgage?
Compare APRs when shopping for a mortgage. APR captures both the interest rate and lender fees, giving you a more complete picture of the total borrowing cost. A mortgage with a lower interest rate but higher fees might have a higher APR than one with a slightly higher rate and lower fees. The APR helps you identify the truly cheaper option.
Does a higher APY mean a better savings account?
APY is the most important factor for comparing savings account earnings, but also consider account minimums, monthly fees, withdrawal limits, and FDIC insurance. A slightly lower APY with no fees may net you more than a higher APY that requires a $25,000 minimum balance. Online banks typically offer the highest APYs because they have lower overhead costs.