Finance · 3 min read
APR vs APY: What's the Difference?
APR (annual percentage rate) is the yearly interest rate before compounding, and on loans it usually includes some fees. APY (annual percentage yield) is what you actually earn or pay over a year once compounding is included. Banks tend to quote APR on things you borrow and APY on things you save, which is not a coincidence: each one makes the number look better from the bank's side.
A quick example
Take a savings account paying 5% interest, compounded monthly. Each month you get 5% ÷ 12 = 0.4167%, and the next month's interest is calculated on the slightly bigger balance. Over a year:
- APR: 5.00%
- APY with monthly compounding: 5.116%
- APY with daily compounding: 5.127%
On $10,000, that's the difference between $500 and about $512 in a year. Not huge, but it's real money, and it grows over longer periods. You can see how compounding builds over decades with the compound interest calculator.
Where it matters more: credit cards
Credit cards quote an APR, but interest is charged monthly (usually calculated daily). A card with a 24% APR compounded monthly has an effective annual rate of about 26.8%. If you carry a balance all year, that's what it really costs you. Compounded daily, it's slightly more, around 27.1%.
That's one reason card debt snowballs so quickly, and why paying a fixed amount above the minimum makes such a difference. The credit card payoff calculator shows exactly how it plays out on your balance, and how credit card interest is calculated walks through the daily maths.
The formula
APY = (1 + APR ÷ n)n − 1, where n is the number of compounding periods a year (12 for monthly, 365 for daily).
The more often interest compounds, the bigger the gap between APR and APY. At low rates the gap is tiny. At credit card rates it's a couple of percentage points.
APR on loans includes fees
On mortgages and personal loans, APR does a second job. In the US, lenders must fold certain upfront costs, like origination fees, into the APR under truth-in-lending rules. So a loan with a 6.5% interest rate and hefty fees might show a 6.9% APR. That's useful: when comparing two loans, the APR gives a fairer picture than the headline rate. It's not perfect, since some costs are excluded, but it's the best single number for comparison.
What about AER and "representative APR" in the UK?
UK savings accounts quote AER (annual equivalent rate), which is the same idea as APY: the rate including compounding. UK credit ads quote a representative APR, which only has to be offered to at least 51% of successful applicants. The rest may get a higher rate, so the rate in the advert isn't a promise.
Which number should you look at?
- Saving? Compare APY (or AER). It tells you what you'll actually earn.
- Borrowing? Compare APR, because it includes fees. For credit cards, remember the effective cost of a balance you carry is a bit higher than the APR.
- Comparing different products? Make sure you're comparing APY with APY, or APR with APR. Mixing them is where people get misled.
A simple habit: when you see a rate, ask "is this before or after compounding, and does it include fees?" Those two questions cover almost every trick in the book.
Frequently asked questions
What is the difference between APR and APY?
APR is the annual rate without compounding (and on loans often includes fees). APY is the effective annual rate including compounding, so it's what you actually earn or pay.
Is a higher APY better?
For savings, yes: a higher APY means more interest earned. For borrowing, you want the lowest APR and effective rate.
What is 24% APR as an effective annual rate?
About 26.8% if compounded monthly, or about 27.1% if compounded daily.
Is AER the same as APY?
Essentially yes. AER is the UK term for the annual rate on savings including the effect of compounding.