APR vs APY — Annual Percentage Rate vs Yield
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| Aspect | APR (Annual Percentage Rate) | APY (Annual Percentage Yield) |
|---|---|---|
| Includes compounding effect | No — simple annual rate only | Yes — accounts for compounding frequency |
| Typical use case | Loans, credit cards, mortgages | Savings accounts, CDs, investments |
| Which is higher | Lower number for the same nominal rate | Always equal or higher than APR |
| Compounding frequency matters | No change regardless of compounding | More frequent compounding → higher APY |
| Regulation | Lenders required to disclose APR (Truth in Lending Act, US) | Banks required to disclose APY on savings products (TISA, US) |
| Example (5% APR, monthly compounding) | 5.00% stated | 5.12% effective yield |
APR and APY describe interest rates, but they answer different questions. APR tells you the stated annual rate before compounding. APY tells you what you actually earn or pay after compounding is applied. Confusing the two leads to poor financial decisions — especially when comparing savings products or loan offers.
APR: The Stated Rate
APR is the simple annual interest rate without factoring in how often interest compounds. If a credit card charges 18% APR, that is 1.5% per month. The card issuer is required by law to disclose this figure clearly. For loans, APR may also include fees (origination, insurance), making it more representative of total borrowing cost than the nominal interest rate alone.
APY: The Effective Rate
APY, also called EAR (Effective Annual Rate) in finance textbooks, incorporates the effect of compounding:
For a 5% APR compounded monthly (n = 12): APY = (1 + 0.05/12)^12 − 1 = 5.116%
For daily compounding (n = 365): APY = (1 + 0.05/365)^365 − 1 = 5.127%
The difference widens as compounding frequency increases and as the nominal rate rises.
Why This Matters for Compound Interest
When you invest, you want to know the APY — not the APR. A savings account advertising "5% APR, compounded daily" will outperform one offering "5.05% APR, compounded annually" despite appearing lower on the surface.
Use Compound Interest to model these differences across different compounding scenarios and time horizons.
Borrowing vs Saving Perspective
Banks are strategic about which rate they advertise. For loans, lenders prefer to show the lower APR (makes borrowing look cheaper). For savings products, banks advertise APY (makes the yield look higher). Understanding this asymmetry lets you compare products on equal terms: always convert everything to APY before comparison.
Quick Rule of Thumb
If the compounding frequency is annual, APR and APY are identical. Any more frequent compounding — quarterly, monthly, daily — means APY will be higher than APR. For high-rate, high-frequency products (like some crypto lending platforms), the gap between APR and APY can exceed several percentage points.
Verdict
Use APY when comparing savings accounts, CDs, or investments — it reflects actual returns. Use APR when comparing loans or credit cards for the stated cost before compounding. To make apples-to-apples comparisons across products, always convert both figures to APY.