APR vs. APY: What’s the Difference?
Learn more about how APR and APY are calculated and why they’re different
APR and APY. They’re similar terms, and they both have to do with interest rates. But what exactly are they? And why are they important?
Simply put, APR is the interest rate stated as a yearly rate. It measures the amount of interest you’ll be charged when you borrow. And APY is the measure of the interest you earn when you save. They may seem similar, but they’re actually very different. And understanding the differences can help you make good decisions about managing your money. Read on to learn how.
What Is APR?
APR stands for annual percentage rate. It typically applies to money you borrow, like with a
- Credit card.
- Car loan, personal loan, home loan or student loan.
- Personal line of credit or home equity line of credit.
APR measures the amount of interest you’ll be charged when you borrow. The lower the APR, the less you may have to pay in interest.
The Consumer Financial Protection Bureau (CFPB) explains that compared with interest rate, “APR is a broader measure of the cost of borrowing money.” APR can include the interest rate plus other costs like lender fees, closing costs and insurance. If there are no lender fees included in the APR, the APR and interest rate may be the same—and that’s typically the case for credit cards.
Because it can include costs like lender fees, the APR may be more useful than the interest rate for comparing certain types of credit offers, like auto financing offers.
What Is APY?
APY stands for annual percentage yield. It typically applies to money you place in a deposit account, like a
APY can show you the amount of interest your investment could earn in a year. Generally, the higher the APY, the more interest your investment could earn. But keep in mind that how much you can earn also depends on how much money you have in your account.
In addition to the interest rate, the APY takes into account compound interest and how often compounding happens in a year. Compound interest means you don’t earn interest on just what you’ve deposited. You also earn additional interest on the interest you’ve already earned.
Because it takes compounding into consideration, the APY can be more useful than the interest rate for comparing deposit accounts. For example, let’s say you’re comparing two deposit accounts that have the same interest rate. The APY might show that the one that compounds daily would earn you more interest than the one that compounds annually.
Keep in mind that the APY for a deposit account is usually variable. That means the APY can change and fluctuate with the market after the account is opened.
The Difference Between APR and APY
APR and APY both measure interest. But APR measures the interest charged, and APY measures the interest earned.
APR is usually associated with credit accounts. The lower the APR on your account, the lower your overall cost of borrowing might be.
APY is usually associated with deposit accounts. The higher the APY on your account, the higher your earnings might be. Just remember that your earnings may also depend on how much money you have in your account—not just the APY.
Ways to Make Informed Decisions About APR and APY
APR and APY can both be useful tools when deciding on the credit or deposit account that’s right for you. But there are a few things to keep in mind:
- How often does interest compound? Interest could compound daily, weekly, monthly, quarterly or annually. Frequent compounding could earn more for your investment accounts and cost more for your credit accounts.
- Have you checked the fine print? Make sure you understand all of the terms and fees. Not all credit accounts include the same fees in their APRs. Some might not include any fees. And deposit accounts may come with fees that aren’t included in the APY.
- Will the rate change? If your rate is fixed, it generally won’t change. But if it’s variable, it’s more likely to change. If you have an introductory APR, make sure you know how long it’s going to last and what your rate will be once the introductory period ends. And keep in mind that the APY for deposit accounts is typically variable and can fluctuate with the market.
- Which APR applies to you? Some credit accounts have different APRs for different types of transactions. For example, credit card issuers might charge one APR for purchases and a different APR for cash advances or balance transfers.
Finally, remember that APR or APY is only one factor to consider when choosing your next credit or deposit account. But knowing what they are and understanding how they impact your finances can be a great start toward helping you make informed decisions.
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