APR vs APY: what's the difference?

Not sure about the differences between APR and APY? Finance can be confusing — but understanding APR vs APY in banking is important, so you can get the best interest rates available whenever you take out a loan or make an investment.

This guide has you covered with the full APR vs APY meaning, how they work and why they matter.

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What is APR?

Let’s start with a breakdown of what APR and APY mean. Firstly, APR, which stands for Annual Percentage Rate.

You’ll see APRs described in the context of loans, credit cards, mortgages and similar products where you’re borrowing money from a bank or institution. APR is the annualized cost of the borrowing, including both the principal loan amount and any connected fees.

For example, if you’re taking a mortgage, you may pay broker costs or other fees as well as the agreed simple interest amount.

Banks are obliged to calculate and show the customer the APR of the mortgage to take into account all the costs involved, and to allow customers to more easily compare several different loans and providers across an even playing field.

How is APR calculated?

The formula for APR is:

[((Fees + Interest/Principal)/n) x 365] x 100

Where:

• Fees = any additional fees paid above the cost of interest and principal

• Interest = total interest paid over life of the loan

• Principal = loan amount

• n = number of days in loan term

If you’re unsure of the APR of a particular product you’ll be able to find it in the bank’s literature and terms and conditions — or you can ask directly for more information and to allow you to shop around and compare products.

What is a good APR rate?

Banks and other institutions set their own APR rates, and so you’ll find a broad selection of rates out there depending on the type of product you’re looking for.

Generally, as APRs refer to money you’re borrowing, you’ll want to look for as low an APR as possible, which suggests a lower overall cost to you over the loan term.

What is APY?

APY is Annual Percentage Yield. This term is used when describing the interest amount available on savings and investment products, so if you’re wondering whether you need the APY vs APR on a savings account, you’ll be looking for APY.

An APY shows the annualized return you can expect on a savings or investment product, taking into account the effect of compounding.

Compound interest is the idea that interest earning opportunities can grow exponentially if money remains invested, and interest paid is added to the principal amount each period. Let’s say you have a savings account which pays interest monthly.

In the first month you’re paid interest on the principal deposit amount. But in the second month you’ll be paid interest on the principal, plus the interest you earned in month one. This pattern continues, so the amount of interest you get can go up with time — handy for investors looking to grow a nest egg.

Banks and investment services show APY to help customers compare products on an annualized basis — so you can compare a CD which pays interest annually against a savings account that pays monthly, for example.

Learn all about APY in our complete guide

How is APY calculated?

The formula for APY is:

(1+r/n)n - 1

Where:

• r = period rate

• n = number of compounding periods

What is a good APY rate?

There’s a broad range of APY rates on different products, so what constitutes a good rate will depend a lot on what you need.

As APY represents the amount of money you’ll get back from an investment or from your savings, you’ll generally want to look for as high an APY as possible to make more of your money.

However, you’ll also need to look at other factors like fees and lock-in periods, to make sure you get the best possible option for your situation.

An example of APR vs APY

While you may come across both APR and APY in banking and financial services, you’ll usually see them in different scenarios.

You’ll see lenders advertising the APR of a loan or a credit card for example. In fact, showing an APR is required under the Truth in Lending Act.

Many banks and organizations — such as Bank of America®¹ — also have their own money education web pages which give examples of how their APRs can be calculated.

To learn more about the APR on your own loans or credit cards, it’s worth checking out the provider’s desktop site, or talking directly to a member of the service team.

APY is usually shown by banks and organizations offering saving and investment products. To get an example of the APY available on different types of saving or investment vehicles it’s worth comparing a few using a major comparison website like NerdWallet®².

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What are the main differences between APR and APY?

As we’ve seen, APR and APY are used in different situations — they’re also calculated slightly differently.

APR covers the interest and other fees charged when you borrow money. However, it doesn’t look at compounding at all.

APY on the other hand, looks at the interest rate payable over the course of a year when you save or invest, taking into account compound interest. However, it does not include the impact of fees.

Which is better, APR or APY?

Neither APR or APY is better, but you’re likely to see both used in different situations. If you’re comparing options for a loan or investment, make sure you’re comparing the same measure — look at APRs side by side for a credit card for example, rather than judging one on APR and one on simple interest.

APR vs APY in savings accounts

For savings account products you’ll usually see APY shown, to make it easier to compare one product against another. APY is a useful measure as it allows you to compare products which pay interest at different times, side by side.

APR vs APY in CDs (Certificates of Deposit)

If you’re considering a CD, you’ll want to look out for the APY of the products for the term and value of deposit you prefer. Often APYs vary based on how much you’re depositing, and how long you’re willing to leave it for,

APR vs APY in crypto investments

If you’re investing in crypto, look out for the APY which should be shown, and which represents the interest you can expect on an annualized basis.

How much and what do you actually pay?

Whether you’re borrowing money or making an investment, APR and APY matter. The APR on any loan, credit card or mortgage you take out will impact the overall costs to you, while the APY on a savings account, investment or CD determines how much you may get as a total return over a year.

If you're borrowing money

If you’re taking a consumer loan, borrowing to buy a vehicle, buying a home with a mortgage or simply shopping with your credit card, the APR will determine the total amount you pay including interest on the principal and any fees.

The exact way this works may vary a little by bank. However, as an example, Bank of America explains APR in the context of credit card payments on its money management education pages.

In this case, the example is of someone with a 17% APR on their card, and an average balance of 2,000 USD over the month.

You can calculate the monthly interest cost by working out the daily interest rate, and multiplying it by the number of days in the billing cycle and the average balance.

If your money is in a savings account

If you’re saving or investing, the APY will determine how much return your money earns, as long as you do not reduce the principal, and you allow the interest being paid to compound.

You’ll be shown the APY when you choose a product — but do bear in mind that the amount you earn can also be impacted by any fees involved with running the account, or if you run into penalty costs — for example for withdrawing money from a CD before the term ends.

Take financial advice from a professional if you’re at all unsure about whether or not a product will suit your needs.

Common questions about APR vs APY

What are the effects of APR and APY on loan repayments?

You’ll see APR shown in the context of loan repayments. This is the annualized cost of the interest on the principal borrowed, and any extra fees. Looking for a lower APR means you’ll pay less in interest overall.

How do APR and APY affect your savings?

You’ll see APY advertised when you look at savings products. This is the annualized amount of interest you can earn, taking into account the impact of compounding. A higher APY can mean you earn more interest on your savings overall.

Can APR and APY change over time?

Banks set their own APR and APY rates, which can change over time depending on the specific product you’ve selected.

What is the difference between an interest rate and APY on a CD?

When you choose a CD you’ll usually be shown the APY. In some cases you may also see a simple interest rate.

The simple interest rate isn’t as useful as an APY as it doesn’t reflect the impact of compounding — the process in which interest amounts earned can increase over time as your principal gets higher once interest is added.

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So there you have it — a full run through of APR vs APY and where you’ll likely run into each term.

No matter whether you’re borrowing or investing it’s important to know what’s happening with your money — and getting to grips with APR and APY can be a good move to help you find the right account, investment or credit card for your needs.

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Sources:

1. Bank of America — APR example
2. NerdWallet

Sources checked 07.10.2023