APR vs. APY: What’s the Difference and Why It Matters

Key Takeaways

• APR (Annual Percentage Rate) reflects the annual interest on loans or credit without compounding, commonly used for credit card and loan rates.
• APY (Annual Percentage Yield) includes compounding, showing the effective annual return on your investment, but does not include fees.
• When borrowing or investing, remember APR and APY differ significantly in fees, compound interest, and more, making direct comparisons between loan and investment products challenging.

You may have heard of both APR and APY, but not been sure what each means. It’s also easy to understand why someone might confuse the terms APR and APY since both are used to calculate interest and both significantly affect how much you earn (or must pay) in relation to your account balances.

But while APR and APY might sound the same, they are actually quite different. In this article, we’ll help you understand what APR and APY are and how to calculate each. We’ll also break down the key differences between the 2 as well as key things to be aware of when comparing APR/APY for different deposit and investment products.

Key Differences Between APR and APY

Some of the main takeaways comparing APR and APY are that:

• APR is usually associated with credit and loan accounts. APY is usually associated with deposit or investment accounts.
• APY takes into account compounding interest, but APR does not.
• APY for deposit accounts is usually variable, while APR is usually fixed.
• APR typically factors in fees, but APY does not.
• The more often interest is compounded, the greater the difference between APR and APY.

Don’t worry if these are confusing — we’ll break down each of these key differences in the next sections.

APR

APR stands for annual percentage rate and measures the amount of interest you’ll be charged when you borrow. The lower the APR, the less you may have to pay in interest. You’ll typically see APR quoted from a borrower for things like:

• Credit cards
• Loans, such as car, personal, mortgage, or student
• Personal lines of credit or home equity lines of credit (HELOC)

The Consumer Financial Protection Bureau (CFPB) states that “APR is a broader measure of the cost to you of borrowing money since it reflects not only the interest rate but also the fees that you have to pay to get the loan.” Those fees include things like lender fees, closing costs, and insurance.

Also, keep in mind that some credit accounts have different APRs for different types of transactions. For example, credit card issuers might charge a certain APR for purchases and a different APR for cash advances or balance transfers.

In some cases, APR and interest rate may be the same — for example, with credit cards. But for the most part, other fees are included in the APR that cause APR and interest rates to be different.

Bottom Line: If the APR is significantly higher than the interest rate, you know you are paying a lot in extra fees.

One of the biggest things to note with APR is that it does not include compound interest. So, while you might hear APR referred to as the “true cost of borrowing,” you’ll likely still need to pay back slightly more than the advertised amount annually due to compound interest.

How To Calculate APR

There are many online calculators, such as this calculator tool, that can easily calculate your true APR by plugging in some key information.

Here’s the formula if you’d like to calculate it yourself:

[((fees + interest paid over the life of the loan) / loan amount) / number of days in the loan term) x 365] x 100 = APR

Let’s look at an example:

Imagine you take out a $30,000 loan at 5% interest for 5 years. You also know that you will be expected to pay a $500 financing fee. Using the APR tool, you’ll see that the actual APR is 6.0223%, which differs from the 5% interest that was advertised. The higher APR means that you’ll pay more for your loan over time.

Hot Tip: The “annual” part APR doesn’t mean that you only pay your loan once a year — in fact, payments are typically made monthly depending on your loan’s payment schedule.

How Can I Get a Better (Lower) APR From My Bank?

How you can ask for a lower APR depends on the product you’re talking about.

Credit Cards

Many cards offer low APRs. These credit cards may not have all the bells and whistles of a rewards or cash-back card, but are a great tool to help manage your interest fees if you regularly keep a balance on your cards.

You may also qualify for a credit card with 0% interest or a balance transfer. If you take advantage of one of these introductory rates, make sure you know how long it’s going to last and what your rate will be once the introductory period ends.

Bottom Line: If you don’t pay off your balance before the introductory period ends, you could be in for a big surprise as interest is usually applied retroactively for the entire introductory period and can result in HUGE interest fees!

If you have an existing credit card with a higher APR and have been a good customer, you can reach out to the issuer and request to have your APR lowered. Be prepared to make a case for yourself as to why you deserve this lower APR — including things like your history of timely payments, how much your credit score has increased since opening your account, and how long you’ve had your account open.

Loans

If you have a new loan, such as an auto loan, you might be able to ask or negotiate a lower rate upfront. According to the CFPB, “dealers may have discretion to charge you more than the buy rate they receive from a lender, so you may be able to negotiate the interest rate the dealer quotes to you.”

If you are negotiating a home loan, you may be able to “buy” points to lower your interest rate. Discuss this option with your lender.

If you have an existing loan with a fixed rate/terms, it is always worth it to ask, but be aware that you may be out of luck as the terms have already been locked into place.

APY

APY stands for annual percentage yield and will show you the amount of interest your investment could earn in 1 year. The higher your APY (also referred to as EAR, or effective annual rate), the more your investment could earn. You’ll typically see APY quoted to an investor for things like:

• Savings accounts
• Money market accounts
• Certificates of deposit (CD)

In addition to the interest rate, the APY takes into account compound interest and how often interest is compounded each year. We’ll discuss compound interest in more detail below, but just know that since APY takes compound interest into consideration, it can be more useful than the interest rate for comparing deposit accounts. 

Hot Tip: APY for deposit accounts are usually variable — meaning that the APY can change with the market rate even after the account is opened.

Unlike APR, APY does not consider any fees, as it is in the bank or financial institution’s best interest to have this number appear as high as possible to win your business.

How To Calculate APY

Again, it’s probably easiest to check out an online APY calculator, but if you want to calculate this yourself, the formula is:

[(1 + (interest / number of compounding periods) ^ compounding periods] – 1 = APY

Let’s look at an example:

Imagine you open a savings account with $30,000 at a 2% interest for 5 years, which compounds monthly. The actual APY is 2.02%, which differs slightly from the 2% interest that was advertised. The higher APY means that you’ll slightly earn more on your loan over time.

How Can I Get a Better (Higher) APY From My Bank?

If you want a higher APY, you’ll want to look into high-interest savings accounts. Your best bet for the highest rate is to find an online bank, as they won’t have as much overhead as traditional brick and mortar banks. This means savings can be passed along to you in terms of a higher APY!

Some banks and financial institutions also offer a higher APY if you keep a certain (higher) amount in your account, so it’s worth asking your current bank if they have any offers like this available

Regardless, shopping around and comparing rates from different banks — both online and in-person — will help you land a better rate.

What Is Compounding Interest?

Earlier we noted that the main difference between APR and APY is compound interest. But what does this mean? Compounding interest is important to understand because as an investor, you want to maximize compounding interest on investments while minimizing it on your loans. 

Compounding interest earns (aka pays) interest on interest you’ve previously earned. This compounded interest can be added to the principal sum of your deposit or loan and will continue to earn money at an ever-accelerating rate in the future. Simply put, as Benjamin Franklin stated: “Money makes money. And the money that money makes, makes money.”

Compound interest is different from simple interest in that simple interest is calculated by multiplying the daily interest rate by the number of days between payments and previous interest payments aren’t a factor at all.

Bottom Line: The Truth in Lending Act requires that lenders disclose loan terms to potential borrowers — including whether interest is simple or compounded.

For example, let’s say you have a savings account with $20,000 in it and you have an APY of 2%. Assuming you don’t add anything else to your account, at the end of 5 years you’ll have:

1. Simple Interest = $22,000.00
2. Interest Compounded Daily = $22,103.36

While this isn’t a huge difference, over time, you will start to accumulate a much larger investment due to compounding interest. This is further magnified if you make regular deposits into your account. It’s also important to look at how often interest is compounding — from annually all the way to continuous. More frequent compounding of interest is good for an investor. For a borrower, the opposite is true. Either way, this difference can make a huge impact on the amount you can make or save on your investments.

Hot Tip: If a loan compounds only once annually, APR and APY would be the same if there are no other fees associated with the loan.

Final Thoughts

When you’re looking to borrow or invest, you should be aware that you’re not always comparing apples to apples. There are big differences between APR and APY, including fees, compound interest, and more that you need to factor in. This can make it difficult to compare loan and investment products.

Knowing key facts about potential options (such as how often interest is compounded, any financing fees, etc) is important. You can use this along with the calculators we’ve linked above to make sure you’re comparing APY to APY between potential options — instead of APR to APY. This will help you make the best choice for your loan or investment!

For further reading, take a look at our guide on what is a good APR for a credit card.