APR vs APY: the key difference
APR represents the annual cost of borrowing including fees, expressed as a percentage. It does not include compounding. APY represents the annual return on savings or investment including compounding, so it reflects the actual earnings rate.
If you are comparing a loan, APR is the figure to focus on because it shows the true cost of credit. If you are comparing a savings account or investment, APY shows the actual yield because it accounts for compounding frequency.
The math in plain language
Suppose you borrow 10000 at 6% APR for one year. The interest you pay is approximately 600 (6% of 10000), because APR does not compound within the year. If the same 6% rate compounds monthly, the APY becomes approximately 6.17% -- the effective rate you actually earn or pay when compounding is included.
The formula difference is simple: APR is a flat annual rate. APY = (1 + periodic rate)^n - 1, where n is the number of compounding periods per year. That is why APY is always at least as large as APR when compounding occurs more than once per year.
When each rate applies
Loans, credit cards, and mortgages quote APR because it reflects the cost of credit without assuming you keep the money invested for a full year. Savings accounts, money-market funds, and certificates of deposit quote APY because it reflects the actual rate you earn when interest is compounded.
If a loan officer gives you one rate and a bank gives you another on a savings product, check which figure they are quoting. A 5% APR on a loan and a 5% APY on a savings account are not comparable -- the APY is likely higher if compounding is annual or more frequent.
Tools to help you calculate
Use the following tools to plug in your own numbers and see the difference APR and APY make for your situation.
Where this comes from
- Consumer Financial Protection Bureau (CFPB) guide to APR and APY
- Securities and Exchange Commission (SEC) investor bulletin on compounding
- Federal Reserve education resources on annual percentage rates