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Understanding Differences Between APR and APY
APR and APY are often listed as valuable points of consideration for financial products, including loans, investments and savings accounts. While they both revolve around interest, these two measurement systems have several key differences. The annual percentage rate (APR) applies to borrowed funds and is typically known as the cost to borrow. The annual percentage yield (APY) applies to investments and represents the interest earned over the course of time.
APR vs. APY: Learn the Key Differences
While both APR and APY measure interest, APR reflects interest charged while APY shows interest earned. These terms are used very differently and you’re not likely to find them in the same financial product. Understanding differences between the two can determine your overall interest when reviewing financial products, such as credit cards, loans and savings accounts.
Applies to money borrowed from
Typically applies to money invested
Shows you the annual borrowing
Shows you how much you could
Does not factor in compound interest.
Factors in compound interest.
Accounts for fees, such as lender fees,
Does not account for fees included
What Is APR?
The annual percentage rate (APR) is the interest paid annually on borrowed money. This rate is expressed as a percentage and is the number best used to compare different lending products.
You often find this in credit accounts, such as credit cards, car and home loans. Compared to simple interest, the APR factors in any fees included in the account — a high difference between the two simply means you're paying a lot in extra fees.
Keep in mind that while the APR is commonly used to differentiate between financial products, it is not all-encompassing. Lending institutions can exclude certain fees and the APR does not take into account compound interest. You may end up spending more than expected compared to your calculations with just the APR in mind.
There are fixed and variable APRs in different lending products. With a fixed APR, interest charges will stay consistent throughout your lending period. Alternatively, your interest rate with variable APR can change depending on the underlying benchmark your lender uses.
Types of APR
Depending on the financial product, there are varying types of APR that can be used. In credit card products, APRs listed in an agreement are based on the type of charge on the account. In loans, it can vary between fixed and variable, the latter of which changes with the index interest rate. Below are a few APR types you should understand prior to applying for a credit card or loan.
Types of APR
Fixed APR’s interest rate remains unchanged throughout the borrowing period, regardless of market rate.
Variable APR’s interest rate fluctuates based on the market rates.
The purchase APR is the interest rate charged to purchases made with a credit card. This is applied to the account if the purchase balance is not paid in full before the credit card’s billing date.
A balance transfer APR applies to any balance that is transferred from one credit card account to another. Typically, this is the same as the purchase APR, but some banks may charge differently.
If you withdraw cash from your credit card’s available line of credit, a cash advance APR interest rate will be applied. This is often far higher than the purchase APR.
After 60 days of missing a payment, or after two payment periods, banks can charge a penalty APR. This is usually the highest APR possible on your account and it will apply for at least six months until they re-evaluate your account again.
Different lenders may offer varying APRs on credit card and loan options when you apply. They calculate rates based on a number of factors, namely your credit score and risk profile — the higher your credit score, the lower the rate you'll get.
What Is APY?
The annual percentage yield (APY), also known as the effective annual rate (EAR), is the rate of return on an investment in a year with compound interest factored in. The APY includes interest earned on your total balance and with interest earned on your profits.
When evaluating investment options, reviewing the APY is a much better indicator of growth compared to simple interest because of the added compound interest. The more periods that interest is compounded, the higher the APY is, which means you’re likely to gain more on your investment.
While the APY is available in savings products, such as your savings account, certificate of deposit or time deposit, it can also apply to loans. You can use the APY to measure the annual cost of a loan with compounded interest.
In any savings product, the higher the APY, the better. A higher APY means that there are more compounding periods and more opportunity to earn gains on your initial investment.
APR vs. APY: How Does Compound Interest Come Into Play?
Compared to APY, the APR does not take compounding interest into account; it only considers the annual interest rate. However, the APY does not take into account any extra fees involved with the financial product, which can deduct from the overall return or add to the overall cost of borrowing money.
For instance, the table below gives an overview on how monthly interest rates on a five-year financial product can change on an annual basis if it’s expressed in APR or APY.
You can also calculate compound interest to see how it impacts what you save or spend.
How to Calculate APR and APY
Banks have plenty of online tools available to calculate the APR and APY, but knowing how to do it yourself can help you quickly calculate on the spot.
The Formula for APR
To calculate the APR, compile any known fee amounts, the simple interest rate and the principal loan amount. Using the formula below, you can begin to find the APR amount. Keep in mind this formula does not account for compound interest.
APR calculation factors:
- Interest = Total interest to be paid over the life of the loan
- Principal = Total loan amount
- n = Total number of days in the loan term
To find the interest, use the following formula:
The calculation factors:
- A = Total accrued amount
- P = Principal or total loan amount
- R = Interest rate
- T = Time period or loan term
To calculate APR, the following steps are used.
Get the interest or total accrued amount
To calculate your total accrued amount, multiply the interest rate of a loan by the loan term. Then, add one and multiply that number by the principal amount. You can find the accrued interest by finding the difference between the total accrued amount and the principal amount.
Add any fees to the interest amount
Next, add any fees, such as closing administrative costs or application fees, to the total accrued amount.
Divide the sum by the principal
Take the sum of the interest and fees and divide that by the total loan amount.
Divide the quotient by the total loan term
With the quotient you got, divide it by the total number of days in the loan term. For example, if your term is one year, the number format should be 365 days. If it’s two years it should be reflected as 730.
Multiply your result by one year
Take the total loan term number and multiply it by one year or 365.
Multiply it all by 100
To convert your result to percentage, multiply the final number by 100. The number you find is your APR.
Example 1: Calculating the APR for a Small Loan
Finding a loan's APR is a great way to discover how much you’re really paying with included fees. For example, you want to borrow $5,000 and the lender’s terms are 5% interest rate for three years with a closing administrative cost of $150 and an origination fee of $200.
To find the total accrued interest over the life of the loan, you would calculate the following:
These are the steps to calculate this formula:
- Add 5% to the total days in the term, which is three years. 5% = 0.05 x 3 = 0.15. Then add one, which represents one year. 0.15 + 1 = 1.15.
- Take your loan amount of $5,000 and multiply it with the 1.15 which equals the interest accrued on the loan. $5,000 x 1.15 = $750.
- Add that back to the loan amount to get the total amount you will pay over the life of the loan $5,000 + $750 = $5,750.
To find the actual APR, you would also add in the fees:
- Add the fees of $150 and $200 to the interest amount.
$705 + $200 + $150 = $1,100.
- Divide this number by the principal amount of $5,000.
1,100/5,000 = 0.22.
- Divide the total number of days in the term, which in this case is three years.
0.22/3 = 0.073.
- Multiply this by one year. 0.073x1 = 0.073. Then, multiply it by 100 to get the final APR.
Example 2: Calculating Your Home Loan’s APR
When you're applying for a home loan, you may have two different lenders offering the same interest rate and monthly payments but different APRs. This could mean that the option with a lower APR has less fees. Review the table below to see how fees can significantly impact your APR.
Assume that you are applying for a loan of $200,000 with an interest rate of 4% and a loan term of 15 years.
Lender with $5,000 in fees
Lender with $15,000 in fees
Total Interest Accrued = $120,000 A = 120,000 + 5,000 A = 125,000/200,000 A = 0.625/15 A = 0.042*1 A = 0.042*100 A = 4.17%
Total Interest Accrued = $120,000 A = 120,000 + 15,000 A = 135,000/200,000 A = 0.675/15 A = 0.045*1 A = 0.045*100 A = 4.5%
The Formula for APY
If you’re evaluating a financial product and need to factor in compounding interest, knowing how to calculate the APY can help. All you need is the interest rate and the number of compounding periods.
- r = Period rate or annual interest rate
- n = Number of compounding periods
To calculate your APY, follow the steps below.
Find your financial investment's annual interest rate and the number of compounding periods to start your calculation.
Use a calculator to divide the annual interest rate by the number of compounding periods.
Add one to the quotient you received.
Using an advanced calculator, raise the sum to the number of compounding periods.
Get the product and minus one. That should now be your APY.
Example 1: Finding Your Savings Account's APY
Calculating your savings account interest is a great way to determine how much you’re getting on an annual basis. For instance, imagine you are getting a 5% interest rate on your savings account with a balance of $5,000. If the compounding period is annually, then you would get an APY of 5.1% and have a total of $5,255, presuming you did not deduct from the account throughout the year.
To find the calculation, you would find the following:
Example 2: Comparing Two Investments with APY
The APY is the best way to determine exactly how much you’ll earn on an investment. For instance, imagine you are contemplating between a certificate of deposit (CD) that offers a 0.5% rate compounded monthly for one year versus a money market account with a 6% interest that compounds every year.
While it may seem like the both options are nearly the same — CD’s annual rate factoring to about 6% (0.5 x 12 = 6%) — when you calculate for the compound interest, the CD has a slightly higher rate. The calculation for APY would be: (1+0.005/12)^12-1 = .501% per month or 6.014% annually.
APR and APY Examples in Various Financial Issues
While you typically use APR for borrowed money and APY for investments, you can use either for any financial situation — just remember that they are not interchangeable. For instance, if you’re trying to factor in compound interest in your credit card, calculate the APY.
Ideally, you want to know what APR and APY are to properly manage your personal finances. This way, you can find a good APR for your credit cards or determine if an investment is right for you.
Understanding APR and APY on a Loan
Whether you’re shopping for an auto loan or a home loan, you want to pay attention to the APR and any compounding of the loan. If there is compounding involved, make sure to calculate for the APY to find the real rate of interest.
For instance, a bank may quote you a 5% APR for a five-year, $100,000 loan. If no compounding interest is involved, you’ll pay a total of $105,000 at the end of the period. However, if it compounds quarterly, you may actually end up having a rate of 5.12% ((1+0.05/20)^20-1 = 5.12%).
By the end of the loan, you would have paid $5,120 in interest or a total of $105,120.
Ideally, you want to look for an APR that does not compound. If it does, annual compounding is better than semi-annually, quarterly or monthly compounding, as it means less chances for interest to grow.
When taking out a loan, getting a good APR can ensure you keep your costs to borrow low. But, what is the ideal APR? Generally, you want to get the lowest rate possible. To do so, it is advisable to get several quotes from different lenders.
Since your APR is based on a number of factors, such as your credit score, debt-to-income ratio, how much you’re borrowing and more, it’s not possible to pinpoint an exact “good” rate as they vary considerably person-to-person.
The Borrower’s Perspective: Every APR Facts You Should Know
The APR is generally the best way to measure the cost of borrowing, but there are several additional key details worth keeping in mind about APR.
Fixed or Variable.
In any contract or agreement, an APR can be referred to as “fixed” or “variable.” A fixed APR means it will not change throughout the contracted period, but a variable APR can change based on the market rate and a number of other factors.
Lenders Must Disclose.
Aside from the simple interest rate, lenders are required to disclose the APR after you submit an application.
Credit Card APRs Vary.
On a credit card, you will encounter multiple APRs, such as a penalty APR and balance transfer APR. Keeping this in mind can help you manage your finances accordingly.
Your Financial History Impact Offers.
A number of factors can affect your APR offers from lenders, such as your credit score and debt-to-income ratio. This is why it’s essential to compare loan offers between different lenders.
Higher Than the Interest Rate = Fees
Since APR is a measuring tool used to include any fees included on the account, having an APR that’s higher than the quoted interest rate means you are paying fees.
How Does APR Affect Credit Card Debt?
Credit card agreements mention various APRs — a purchase APR, balance transfer APR, cash back APR, penalty APR and sometimes even an introductory APR. A high APR on purchases, balance transfers or cash back means that it may be hard to pay off your card balance if you only pay the minimum.
For instance, if you have a balance of $5,000 from purchases and an APR of 15% that you pay off with at least $200 each month, it would take you at least 32 months to pay it in full with $1,031 in accrued interest. If you only pay the minimum, it may take you longer to pay it off.
To keep your credit card debt to a minimum, explore for low-interest credit card options and pay more than the minimum amount due each month. This will help you avoid compounding interest.
How Do APR and APY Work on Mortgage?
Understanding both APR and APY is the key to finding your ideal mortgage; otherwise, you may end up spending more if you only base your decision on initial quoted rates.
With home loan quotes you may often see the interest rate and the APR. These two are not the same. The interest shows the cost to borrow money, while the APR expresses the same but with fees and other charges involved. Such charges can include your insurance, the origination fee and lender fees.
When comparing APRs between home loan offers, the lowest is generally the best. You want to get the lowest fees and the lowest interest. However, things can change if the loan involves compounding interest. Checking for the frequency of compounds will show you what the APY will be over the course of time.
For instance, if you have a $200,000 mortgage with a 4.5% interest compounded quarterly, your APY is: (1+4.5%/4)^4-1 = 0.458 or 4.58%.
In reality, you would pay back the loan each month. The table below shows how interest compounds and your total balance accrues assuming no payments are made each quarter.
Total Interest Accrued
Over a year, the cost of borrowing is $9,153 or an APY 4.58%. Compounding interest increased the total cost of a loan, creating a new “real” interest rate in this example.
Prior to selecting your home loan, you should calculate the APY over the course of the loan, factoring in the number of times interest is compounded, to ensure you know the actual cost you’ll be paying. A mortgage calculator is a great tool that can help you quickly find costs associated with loan offers and lender fees.
How Will APR and APY Influence Your Savings Account?
Typically, you won’t use an APR in savings products; banks will often show you the APY instead to showcase how much you can earn from the investment. A high APY is best as it means you’ll likely receive more in return for your investment.
For example, the graph below shows just how much you can earn from a savings account with an initial investment of $10,000 and monthly contributions of $1,000 with a 0.5% annual interest rate.
Total Interest Accrued
In this example, the amounts are small because savings accounts do not earn much per year. Imagine if you invested the same amount in a money market account that compounds monthly with a 6% interest rate — you’d make $952 by your first year with the same contributions!
What Is a Good APY for Savings Accounts?
A good rule of thumb for savings accounts’ APY is to stick to somewhere around or above the national average. The FDIC’s National Rates and Rate Caps report notes that 0.06% is the national average APY for savings accounts, so try to stick to this number or higher.
If you want to start saving and investing your money in a place other than your usual savings account, consider a high-yield savings account (HYSA). It’s an account that has a higher rate than your typical savings account with the same amount of liquidity.
Prior to getting an HYSA, keep the following tips in mind:
- Aim for a High Interest Rate. To earn the most, you want to find a high-yield savings account with an excellent rate. Check the rate at your bank if they offer this product and use that as a benchmark when you shop elsewhere.
- Look for Little to No Fees on Regular Use. Some banks may charge you a fee for uncommon activities such as overdrafting or wiring money and you should avoid charges for normal activities, such as withdrawals.
- Make Sure You Can Transfer Money Easily. You want to be able to have easy access to your money. Find a provider who can let you make transfers to linked accounts and those that can link to any U.S. account.
- Choose Your Provider Based on Your Needs. If your current provider already offers one of the best HYSAs, go online and apply through their website — it keeps you to one account. However, you can also benefit by choosing a new institution, as some providers may offer a far better product. Evaluate whether opening a new account elsewhere is beneficial by weighing their offers against what your bank can provide.
How APY Can Maximize Your Investment
Knowing and understanding what APY represents is the best way to ensure your investments are beneficial for you. With this information, you’ll be aware of how much your investment accrued in interest annually. When determining how to select the best APY for you, keep the following tips in mind:
Higher is Better.
A high APY means you’re likely to earn more from an investment in a year. The more frequently interest is said to compound on a product, the better.
Fixed or Variable?
When evaluating a product’s APY, take a look at whether it is fixed or variable APY. A fixed APY means the rate won’t change on the savings or investment account over time but a variable APY can fluctuate based on the market. If you’re looking for stability, stick with a fixed rate, but keep in mind there can be risks, such as losing money earnings during periods of inflation.
Mind the Fees.
Even though APYs can be high, it does not disclose all the fees involved in your investment. You may end up making less than you anticipated if you didn’t account for fees. Ask for the APR to get an idea how much your rate is with fees included.
APR vs. APY FAQs
APR and APY can be confusing terms for anyone who wants to get started with saving and investing, but understanding them is essential for making solid financial decisions. Learn more about APR and APY from the frequently asked questions below.
Both APR and APY can give you a better look at your financial products. While the APR can provide a snapshot of a rate with fees included, the APY can give you an overview of your compounded interest. Both of these can be confusing for those new to the world of finance. MoneyGeek checked in with industry experts for their insights to help you understand each measurement better.
- What is the quickest way to tell if an APY is good? And how can you tell if an APR is bad?
- What other considerations should you take into account when reviewing an APR and APY?
Supervising Attorney at The Bankruptcy Law Center
Change Management Consultant, Business Strategist, & Executive Mentor at Babbitt Consulting
Small Business Finance Expert and Writer at Fit Small Business
Learning about concepts that impact your savings or credit accounts is just as important as understanding APR vs. APY. Explore the guides below to learn more strategies to make wise financial decisions surrounding your savings, debts and investments.
- What Is a Good APR for a Credit Card? Knowing what a good APR is for credit cards can help you find an ideal option for your financial situation. Learn more about identifying good APR, how to compare cards and how to qualify for a good APR.
- How Does Credit Card Interest Work? Find out how credit card interest works, including how to calculate interest, what types of interest there are and how to avoid credit card interest where possible.
- 11 Ways to Start Saving Money: If you want to start saving but don’t know where to start — don’t worry. Learn how to save from the ground, from budgeting to consolidating debt.
About Nathan Paulus
- Consumer Financial Protection Bureau. "What is the difference between a fixed APR and a variable APR?." Accessed December 6, 2021.
- Federal Deposit Insurance Corporation (FDIC). "National Rates and Rate Caps." Accessed December 6, 2021.
- Federal Reserve Board. "Consumer Credit - G.19." Accessed December 6, 2021.
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