Quick comparison: APR vs APY — the bottom line

  • APR (Annual Percentage Rate): the yearly cost to borrow, expressed as a percentage. Used on mortgages, credit cards, and personal loans. It often reflects interest and some lender fees but does not include compounding on deposits. (Consumer Financial Protection Bureau)
  • APY (Annual Percentage Yield): the yearly rate of return you actually earn on a deposit account after compounding. Banks and credit unions use APY to show how savings grow. (FDIC)

Understanding the distinction matters because a low APR doesn’t always mean the cheapest loan once fees and amortization are considered, and a higher nominal interest rate on a savings account may yield less than a published APY if compounding frequency or restrictions apply.

How APR and APY are calculated (plain-language formulas)

  • APY formula (standard): APY = (1 + r/n)^n – 1, where r is the nominal interest rate and n is the number of compounding periods per year. This gives the effective annual yield after compounding.
  • APR (nominal) for loans typically equals the periodic interest rate multiplied by the number of periods per year. When lenders include required fees (points, origination charges), they disclose an APR under the Truth in Lending Act to help consumers compare offers (Consumer Financial Protection Bureau: Truth in Lending Act disclosures).

Example — APY vs nominal rate:

  • A savings account with a 1.95% nominal rate compounded daily (n = 365) has APY = (1 + 0.0195/365)^{365} – 1 ≈ 1.97% APY. That small difference is compounding at work.

Example — APR on a mortgage vs interest rate:

  • A lender quotes a 3.25% interest rate but charges 1 point (1% of loan) in closing costs. When those upfront fees are amortized over the loan term, the APR disclosed may be 3.45% — higher than the note rate. That APR helps compare total cost across lenders who charge different fees.

(For official guidance on APR disclosures see the CFPB and Truth in Lending materials.)

What banks and lenders don’t always make obvious

  • Compounding frequency matters for savers. Daily compounding beats monthly compounding on identical nominal rates. Advertised “up to” APY or promotional rates can require a minimum balance or limited-time windows.
  • Fees and required services can change the effective cost. Origination fees, points, prepayment penalties, and even required insurance may not be obvious in a headline rate; APR disclosure should capture many of these costs, but not all (CFPB).
  • For loans with variable interest or balloon payments, the APR assumes payments are made as scheduled; real-world behavior (refinancing, early payoff) changes your true cost.
  • Credit card APRs can be misleading when translators ignore daily compounding vs simple interest, late fees, and penalty rates. The way interest accrues on revolving balances (average daily balance vs adjusted balance) affects how quickly interest builds.

Real-world examples that show the difference

1) Savings account: $10,000 at 2.00% nominal rate.

  • If compounded monthly: APY = (1 + 0.02/12)^{12} – 1 = 2.02% → you earn about $202.02 in one year.
  • If compounded daily: APY ≈ 2.02% as well but fractionally higher.

2) Short-term loan: $5,000 personal loan at 6.00% interest with a $150 origination fee.

  • Nominal interest on a 2-year amortization = 6.00%. But the APR that reflects the $150 fee will be higher once the fee is spread over the loan term. That APR is the figure you should compare to other offers.

Practical checklist: How to compare offers effectively

  • For deposits: compare APY rather than the quoted nominal rate. Check compounding frequency, balance tiers, and introductory terms.
  • For loans: compare APRs, but read the fine print for excluded fees (late fees, insurance requirements). Ask how fees were treated in the APR calculation and whether points are refundable.
  • For credit cards: check APRs for purchases, balance transfers, and cash advances separately. Also confirm grace-period rules and whether interest is charged on new purchases when carrying a balance.
  • For promotional offers: note the length of the promotion and the post-promo rate. Calculate the break-even point when an introductory APY or 0% APR offer ends.

Common misconceptions and how they cost you

  • “Lower APR always means cheaper loan.” Not always — upfront fees or a short-term loan with high monthly payments can make a lower APR less advantageous. Use total finance charges and the APR disclosures to run comparisons.
  • “APY and APR are interchangeable.” They are not. APY measures earned return including compounding; APR measures most costs of borrowing and is not a compounding yield.
  • “A bank’s posted rate is guaranteed.” Often rates are “promotional” or tiered, and banks may add conditions (e.g., minimum direct-deposit requirements) that affect the APY you receive.

Tools and calculations you can run quickly

  • Use an online APY calculator or a spreadsheet to plug in nominal rate and compounding frequency. The FDIC and many banks publish APY calculators.
  • For loans, ask for a loan amortization schedule and the full Truth in Lending disclosure. The APR in that disclosure lets you compare offers apples-to-apples under U.S. law (Truth in Lending Act, as summarized by CFPB).

Strategies to get better outcomes

  • Negotiate fees and points, especially on mortgages. Reducing or waiving an origination fee can lower your APR materially.
  • For savings, look for accounts with high APYs and frequent compounding, but confirm there are no hidden minimum balance requirements or tiered reductions.
  • Match product to need: use short-term low-fee credit for temporary cash needs; use low-APR, longer-term financing for major purchases only when the extended payments genuinely lower your total cost.
  • Consider the effective annual rate (sometimes called EAR or EAPR) when comparing loans with frequent compounding — this is the APY equivalent for borrower-facing comparisons.

Interlinks for deeper reading

Frequently asked questions (concise answers)

  • Should I always choose the higher APY savings account? Only after confirming compounding frequency, fees, and balance conditions. A small difference in APY compounds over time, so for long-term savings it matters.
  • Can APR change after I take out a loan? Fixed-rate loans keep the contract APR stable, but variable-rate loans can change. Also, penalty pricing can raise APRs for credit cards under certain circumstances.
  • Does APY apply to certificates of deposit (CDs)? Yes — CDs use APY to show the effective annual yield given their stated compounding schedule.

Sources and authority

This article is educational and not personalized financial advice. For guidance tailored to your situation, consult a qualified financial advisor or a licensed lender. In my experience editing and reviewing client cases, clear comparison of APR and APY (and a careful read of fee disclosures) prevents costly mistakes and helps you choose the product that fits your timeline and goals.