FINFinance
APY vs APR: What’s the Difference and Which One to Compare?
Published 4 min read
APR (annual percentage rate) describes the yearly cost of borrowing, while APY (annual percentage yield) describes what a deposit actually earns in a year once compounding is counted. Use APY to compare savings accounts and certificates, and APR to compare loans and credit cards. Because APY includes interest earned on interest, it is the more honest figure for savers, and it will always be equal to or a little higher than the nominal rate it is based on.
Two rates, two jobs
Banks quote different figures depending on whether money flows to you or from you. A borrower wants to know what a loan will cost; a saver wants to know what a balance will grow to. In the United States, rules on truth in lending and truth in savings push lenders toward APR and deposit-takers toward APY, which is why a single bank's website can show both numbers on different pages.
| APR | APY | |
|---|---|---|
| Typically used for | Mortgages, personal loans, car finance, credit cards | Savings accounts, money market accounts, certificates of deposit |
| Includes compounding? | No, it is a simple annual rate | Yes, it reflects how often interest is added |
| May include fees? | For many loans, certain lender fees are folded in | No, it reflects interest only |
| Which direction is better? | Lower | Higher |
Other countries use different labels for the same ideas. In the UK, for example, savings accounts quote an AER (annual equivalent rate), which plays the role APY does in the US.
Why compounding makes the difference
Compounding means interest is added to your balance at intervals, and each later interest payment is worked out on that larger balance. The more often interest is added, the more the yearly result creeps above the stated rate.
The standard formula is APY = (1 + r/n)n − 1, where r is the nominal annual rate as a decimal and n is the number of compounding periods in a year. Take a made-up nominal rate of 5% to see the pattern:
- Compounded once a year, the APY is 5.00%.
- Compounded quarterly, it works out at roughly 5.09%.
- Compounded monthly, about 5.12%.
- Compounded daily, about 5.13%.
The gaps are small at modest rates, but they are real, and they explain why two accounts with the same headline rate can still pay slightly different amounts.
How interest on a savings account is calculated
Most banks calculate interest daily on the balance at the end of each day, then credit it to the account monthly or quarterly. A few use the average daily balance over the statement period instead. The details sit in the account terms, usually under headings such as "interest calculation" or "balance computation method". It is worth checking three things:
- How often interest is calculated, which is usually daily.
- How often it is credited, since interest only starts earning more interest once it lands in the balance.
- Whether the rate is variable, because a quoted APY assumes the rate stays put for a year, which variable accounts do not promise.
Our piece on how high interest savings accounts turn small deposits into big wins shows how regular deposits and compounding work together over longer stretches.
Where APR can mislead
APR is useful, but it has blind spots. On a credit card, the APR is simply the interest rate; card interest usually compounds, so carrying a balance can cost more than the APR alone suggests. On a mortgage or personal loan, the APR may include some fees but not every cost, and two lenders may treat fees differently. Short-term property finance is often quoted as a monthly rate rather than an annual one, as our look at fast bridging loans in the UK touches on, so convert figures to the same basis before comparing.
Which number should you compare?
- Choosing where to save: compare APY (or AER) between accounts, then check fees, minimum balances, access rules and whether the rate is promotional.
- Locking money away for a term: compare APY on certificates of the same length, and read the early withdrawal terms. Spreading money over several terms is covered in our guide to what a CD ladder is and how it works.
- Borrowing: compare APR on loans of the same amount and term, then ask for a full breakdown of fees and the total amount repayable.
- Credit cards: compare APR for purchases, balance transfers and cash advances separately, as they often differ.
Common mix-ups
Is a higher APY always better?
For the interest itself, yes. But an account with a slightly lower APY and no monthly fee can leave you better off than one with a higher APY and charges, and a promotional rate that drops after a few months may not beat a steady one.
Can I convert APR to APY?
Yes, if you know how often interest compounds: plug the APR into the formula above as r. This tells you the effective yearly rate on a balance, which is handy when comparing a loan quoted one way with a product quoted another.
Does APY tell me how much I will earn?
Only if the balance and rate stay the same for a full year. Deposits, withdrawals and rate changes all shift the actual amount, so treat APY as a comparison tool rather than a promise.
Rates, fees and protections vary by provider and country, and this article is general background rather than advice. For decisions that involve larger sums or borrowing against your home, a qualified financial adviser can look at your own situation.
Questions? Write to us.
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