APY vs. APR: What's the Difference and Why It Matters
Banks advertise APY on savings and APR on loans — and it's not a coincidence. Understanding the difference helps you compare accounts accurately and avoid being misled.
The Short Version
APR (Annual Percentage Rate) is the interest rate without accounting for compounding. APY (Annual Percentage Yield) is the effective rate after compounding is factored in. For the same nominal rate, APY is always higher than APR — and banks know exactly which one to advertise on which products.
How APR Works
APR is simple: it is the stated yearly interest rate. If you borrow $10,000 at a 6% APR, you owe $600 in interest over a year — straightforward. APR is used for mortgages, auto loans, credit cards, and personal loans because it is required by US law (Truth in Lending Act) and provides a baseline comparison number.
The problem with APR is that it ignores compounding. A credit card with a 24% APR does not cost you exactly 24% of your balance per year — it costs more, because interest is compounded daily on most cards.
How APY Works
APY tells you what you actually earn (or pay) after compounding is applied. The formula:
n = number of compounding periods per year
For a savings account with a 5% APR compounded monthly (n = 12):
That extra 0.116% might seem small, but on $50,000 it is an extra $58 per year — and the gap grows with higher rates and longer time horizons.
APR vs. APY at Different Compounding Frequencies
| APR | Compounding | APY |
|---|---|---|
| 5.00% | Annually | 5.000% |
| 5.00% | Monthly | 5.116% |
| 5.00% | Daily | 5.127% |
| 10.00% | Monthly | 10.471% |
| 24.00% | Daily | 27.110% |
Notice the last row: a credit card with a 24% APR compounded daily has an effective APY of over 27%. This is why the stated APR on credit cards understates the true annual cost of carrying a balance.
Why Banks Advertise Them Differently
Regulations require disclosing both numbers in many contexts, but banks choose which to lead with:
- Savings accounts and CDs: Advertised as APY, because APY > APR. A 5% APR becomes "5.12% APY" — sounds better.
- Mortgages and auto loans: Advertised as APR, because APR < APY. The rate looks lower, even though compounding applies.
- Credit cards: Disclosed as APR by law, but the daily compounding makes the true cost higher than the stated APR implies.
Practical Rules
When comparing savings accounts or CDs, always use APY — it is the true return you will receive. When comparing loans, look at the total interest paid over the life of the loan rather than relying on APR alone, especially for longer-term debt.
For a quick mental model: if you are earning interest (savings, CDs, money market), APY is your friend — it tells you what you actually receive. If you are paying interest (loans, credit cards), the real cost is at least as high as the APY, and often higher once fees are included.
CDs: Where APY Is Most Useful
Certificate of deposit (CD) rates are almost always quoted as APY, making direct comparison easy. A 6-month CD at 5.25% APY and a 12-month CD at 5.00% APY are not directly comparable on time alone — you need to account for reinvestment risk (what rate will you get when the 6-month CD matures?). If rates are falling, the 12-month CD locks in the higher rate longer.
Key points
- APY is always ≥ APR. The difference grows with higher rates and more frequent compounding.
- Banks advertise APY on savings (looks higher) and APR on loans (looks lower). Both are legal and accurate — just strategically chosen.
- Compare savings accounts and CDs using APY. Compare loans using total interest paid.
- A credit card's true annual cost (after daily compounding) is higher than its stated APR.
Frequently Asked Questions
Which is higher, APR or APY?
APY is always equal to or higher than APR, because APY accounts for the compounding effect. For a savings account with a 5% APR compounded monthly, the APY is 5.116%. The difference grows at higher rates and more frequent compounding.
Why do banks use APY for savings but APR for loans?
Because it makes each product look more attractive. APY makes savings rates look higher than they are on a simple interest basis. APR makes loan costs look lower than the true compounded cost. Knowing this, always compare savings accounts by APY and loans by their total cost or effective rate.
What is the APR on a credit card vs. the daily rate?
Divide the APR by 365 to get the daily periodic rate (DPR). A 24% APR = 0.0658% per day. Your balance is multiplied by this rate each day, then added to your balance — which is why balances can grow quickly if you only make minimum payments.
Does a higher APY always mean a better savings account?
Usually yes, but check for conditions: minimum balance requirements, limited withdrawals, or introductory rates that expire. A 5.5% APY with a $10,000 minimum may be worse for you than a 5.0% APY with no minimum if you cannot maintain that balance.
Try it yourself