APY vs APR – Understanding the Difference

One of the most important considerations that you will run into, whether you borrow money or are looking for a return on a cash product, is the interest rate. The interest rate tells you how much you will be charged on a loan, and how much you will earn on a CD or savings account. When you get a loan, you want to pay as little interest as you can, and when you are earning interest, you want it to be as high as possible.

APY vs APR image

Interest is expressed either as an annual percentage rate (APR) or as an annual percentage yield (APY). You should understand the difference between these two expressions in order to better understand your money and what you’re really being charged when borrowing money.

Annual Percentage Rate – APR

You will most often see loan offers (including credit cards) use APR to express the base interest rate being charged. This is because the APR looks at the annual rate that comes with the loan, but doesn’t take into account compound interest.

When you see a credit card offer for 13.99% APR, that’s your base rate. However, the interest that you actually end up paying at the end of the year if you carry a balance is going to be a little bit higher because the APR doesn’t include compounding.

Annual Percentage Yield – APY

This is the rate that takes into account compound interest. This is when you pay interest on your interest. The interest on a loan is figured at regular intervals. Once that interest is determined, it is added to the balance of the loan, and you pay interest on the new total. The formula used for determining APY is as follows:

APY = (1+ (r/n))^n – 1

r = the stated interest rate

n = the number of times compounded

It’s important to note that the stated interest rate should be divided by 100 before completing this formula, so 13.99% would be 0.1399 when plugged into the formula. When you finish the calculation, multiply by 100 to express the answer as a percentage.

As a result of this operation, your APY on the credit card listed above, if the interest is compounded monthly, is actually 14.92%. If your credit card compounds interest daily, the APY is even higher: 15.01%. When you look at the APR of a credit card, you might think that the 13.99% means that you pay $13.99 in interest if you have $100 for the year. That’s what the credit card issuers would like you to have in your mind. However, if your interest is compounded daily, you will pay $15.01 on that $100 by the end of the year.

You can see why credit card issuers offer the APR instead of the APY — the APR is a much more attractive number for borrowers.

At the same time, it is clear why banks advertise their savings accounts and CDs using APY. You end up with higher advertised interest earnings.

It’s Better to Earn Interest that to Pay It

The difference between APR and APY is an important distinction to make. You can see what you’re really paying when you use a credit card. This illustration also emphasizes that it is much better to earn interest than to pay it.

When you are paying interest, the money goes right to someone else. You don’t receive new goods or services for your payment. Instead, you simply pay for the ongoing privilege of borrowing the money. When your loan is subject to compound interest, it can actually grow in size over time, since the interest adds to the balance. This is one of the reasons that it’s so important to pay more than the minimum when you are trying to get rid of credit card debt.

Earning interest, though, is a much better proposition. Interest can increase your wealth over time. Compounding interest builds on itself over time, offering you the chance to accelerate your earnings and increase your wealth. It’s important to consider that point as you make your financial plans.

Picture by FreeDigitalPhotos.

About the Author

By , on Feb 19, 2013
Miranda is a freelance writer and professional blogger, specializing in financial topics. She has written for a number of financial web sites, and her work has been linked to by many publications, online and off. Miranda's blog is Planting Money Seeds.

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  1. Good explanation. I’m always a big fan of math lessons. I agree that it is better get interest than to pay it.

  2. S. B. says:

    I love how banks quote savings rates in APY and borrowing rates in APR. It’s a wonderful method of obfuscation.

  3. Thanks for explaining all of this. Sometimes we chose to ignore the numbers or think they are what they are until we dig a bit deeper.

  4. Jose says:

    That is an great explanation of the difference between the rate and yield. There’s a good reason compounding is called the eighth wonder of the world !

  5. I think in the UK the APR is a defined a little differently. I had a run-in with MBNA (part for your favourite BoA) and the way they calculate and quote the interest was impossible to see to start with.

    Eventually they sent a few months daily calculations and they were basing the quoted rate on the monthly rate compounded for the annual calculation, but using a simple interest across a standard 365/12 days per month for the daily calculation!

    This is wrong and made worse by the fact that their accounting period was never a month anyway – it was 4 weeks or 5 weeks. A true daily rate would have been a little lower although in my case it would not have made a lot of difference.

  6. Great explanation. Most people, self include, tend to let their eyes glaze over at the though of any sort of math. This is a really easy way to understand it. Best point is for sure to not pay, but earn interest!

  7. Great explanation, even my peanut sized brain can process it! And I agree, I can’t wait until I’m earning more in interest than I’m paying out!

  8. Great explanation. I know the difference can confuse a lot of people, especially with all the numbers that get tossed out in car commercials and the like.

  9. Excellent breakdown! I wish the marketing collateral that banks and other financial institutions gave out had more clear descriptions.

  10. I’ve never understood the difference between the two before but your article does a great job of showing the differences. Now when I go looking at new credit card this could come in very handy to see what interest rates they are really charging when your interest rates compound.

  11. Don’t forget that this can apply to investments as well. If you have a contract based investment or bond check and see how the yield or interest is quoted. If it is in APR terms, it is good to know when and how often it is compounded.

  12. Debt RoundUp says:

    Nice breakdown Miranda. I have always laughed when I see APR especially when you have to dig to find the compounding method that is used. It would be much nicer to use APY, but this is just a little marketing gimmick!

  13. Fantastic explanation Miranda, I’ll try and work the formula out later though 🙂

  14. I used to think they were the same thing until I started reading personal finance blogs.

  15. Very good explanation of the differences between the two Miranda. I worked at a bank years ago and was always amazed how the difference would throw many people.

    • Miranda says:

      It’s not something that a lot of people think about or understand. Until a few years ago, I thought the difference was that one was for savings and one was for loans. Learning curve. 🙂

  16. Very good description, Miranda.. Lenders tend to float the APR as the “true” number, when it actually is APY that we should be paying attention to..

    • Miranda says:

      Yeah. We get so caught up in APR that we forget that it might not be the most accurate or realistic measure of what we’re REALLY paying if we carry balances.

  17. Thank you for that very clear description of APR and APY.

    I agree that earning interest is better than paying it. It goes along with my philosophy that simply states, my money is best spent making more money. Hence, I keep my savings rate high, and work hard to channel the savings into investments that produce passive income streams.

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