APR and APY are both used to express interest rates, but they measure different things. Confusing them leads to underestimating what a loan actually costs or overestimating what a savings account actually pays. Financial institutions are not always transparent about which one you’re looking at.
APR: Annual Percentage Rate
APR is the annual cost of borrowing expressed as a percentage of the loan balance. For simple interest products, it represents the interest rate without compounding. For credit cards and mortgages, APR also includes certain fees — origination fees, closing costs, or annual fees — amortized over the loan term.
APR is required by law to be disclosed on most consumer loans under the Truth in Lending Act, which is why you see it prominently on credit card agreements and mortgage disclosures. It was designed to give borrowers a standardized way to compare loan offers.
Where APR appears
- Credit cards (purchase APR, cash advance APR, balance transfer APR, penalty APR)
- Mortgages (the APR is usually slightly higher than the stated interest rate because it includes fees)
- Auto loans
- Personal loans
APY: Annual Percentage Yield
APY accounts for compounding. When interest is compounded more than once per year — monthly, daily, or continuously — you earn interest on your previously earned interest. APY captures this effect, making it a more accurate representation of what you’ll actually earn (or owe) over a year.
The more frequent the compounding, the higher the APY relative to the base interest rate. A savings account with a 5% interest rate compounded daily has an APY slightly above 5% because interest compounds 365 times per year.
Formula: APY = (1 + r/n)^n − 1, where r is the annual rate and n is the number of compounding periods per year.
Where APY appears
- Savings accounts
- Certificates of deposit
- Money market accounts
- High-yield savings accounts
Why the Distinction Matters for Borrowers
Credit cards typically state their rates as APR, but interest on unpaid balances is usually compounded daily. The effective cost of carrying a credit card balance is therefore higher than the stated APR.
Example: A credit card with a 24% APR and daily compounding has an effective APY of approximately 26.82%. If you carry a $2,000 balance all year and make no payments, you owe roughly $536 in interest — not $480 (which the 24% APR alone would suggest).
Why the Distinction Matters for Savers
Banks advertise savings accounts using APY because it’s the higher number — it shows what you’ll actually earn including compounding. Two accounts with the same base interest rate but different compounding frequencies will show different APYs.
When comparing savings accounts, APY is the right number to use — it reflects your actual earnings. When comparing loan offers, APR is the baseline comparison (though looking at total interest paid over the full term is even more useful for large loans).
Mortgage APR: More Complex
Mortgage APR includes the interest rate plus most lender fees (origination fees, discount points, mortgage broker fees, prepaid interest) spread over the loan term. This makes the APR on a mortgage higher than the stated interest rate.
For example, a 6.5% mortgage interest rate with $4,000 in origination fees on a $300,000 loan might have an APR of 6.72% when the fees are factored in. This makes APR useful for comparing mortgages from different lenders when one charges more fees but a lower rate — the APR normalizes the comparison.
However, APR assumes you keep the loan for its full term. If you refinance or sell within seven years, a loan with lower fees and a slightly higher rate may actually cost less than the lower-APR loan that had high upfront fees. For short-term plans, look at the total cost over your expected ownership period rather than APR alone.
Quick Reference
| Metric | Used For | Includes Compounding? | Includes Fees? |
|---|---|---|---|
| APR | Loans, credit cards | Not always | Sometimes (mortgages, loans) |
| APY | Savings, investments | Yes | No |
The rule of thumb: when borrowing, the effective cost is usually higher than the stated APR. When saving, the APY tells you the true yield. Knowing this prevents making financial comparisons based on the wrong metric — which lenders and banks know, and which gives them an incentive to use whichever number presents their product most favorably.
