APR vs. APY: The difference explained

It’s easy to get confused when the concepts of annual percentage yield (APY) and annual percentage rate (APR) are being tossed around. You’ve probably come across these acronyms when opening new financial accounts or reviewing the terms on your existing accounts, but what exactly do they mean? What is the difference between APR and APY?

Now, roll up your sleeves for a deep dive into APR vs. APY:

APR vs. APY

If you’re wondering, “What is APR, and what is APY?” here’s a quick primer. In their simplest forms, APR refers to what you owe when you borrow while APY refers to what you earn on the cash that’s stashed in a savings vehicle. While it may sound like something that belongs in an advanced finance class, understanding the difference between APR and APY can help you make smart financial decisions when it comes to saving for your financial goals and managing your debt.

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Now, you’re ready for a deeper dive into the differences between APR vs. APY:

What is APR?

The APR is the total amount of annual interest you pay on an installment loan or revolving line of credit. “If you’re getting a loan, that’s usually the number you’re going to see,” says Erik Goodge, CFP®, president of a financial planning solutions group based in Newburgh, Indiana, of APR.

When you’re learning APR vs. APY, note that you may see an APR associated with:

• Credit cards and store cards
• Auto, home, personal, and student loans
• Lines of credit, including home equity lines of credit (HELOCs) and personal lines of credit

When considering a new credit card or loan option, evaluating an account’s APR can be more telling than evaluating its interest rate. While APR is based on the interest rate, it may also include some of the lender’s fees, points, and other costs associated with credit, Goodge says.

Say you’re comparing two lenders that both offer $1,000 loans with a 10.00% interest rate. Lender A charges a $50 fee and adds it to your loan’s balance. Lender B does not. If you compare the APRs, Lender B will likely have the lower APR. Come again?

This is because with Lender B, the 10.00% interest rate applies to your $1,000 loan. With Lender A, on the other hand, you may pay more in interest because the 10.00% interest rate applies to the $1,050 (the loan amount plus fee) you have to repay.

When considering APR vs. APY, know that in some cases a loan with a lower interest rate but high fees could have a higher APR than a loan with a higher interest rate and lower fees.

What to know when comparing APRs

Similar to comparing only APYs on a deposit account, comparing just the APR on a new credit card or loan may not tell you the whole borrowing story. Lenders might include different charges when making their APR calculations.

“If you’re comparing quotes from different lenders, you need to look closely to see which fees it includes,” says Justin Pritchard, CFP® and owner of an independent financial planning practice based in Montrose, Colorado.

With credit cards, for example, the annual fee may not be reflected in the APR. If you’re comparing two cards with the same APR, you’ll also want to look at the annual fee to understand your potential expense. Credit cards may also have multiple APRs depending on the type of transaction. For instance, the APR for cash advances could be higher than the one for regular purchases.

When evaluating APR vs. APY, know that a loan’s APR is calculated assuming you’ll take the entire term to pay it off. So, if you’re comparing 30-year mortgages, but you plan on moving in five years, you may want to recalculate the APR taking the shorter term into consideration. You could learn that a loan with fewer upfront fees winds up being a lower cost, even if it has a higher advertised APR.

What is APY?

Now that we’ve answered, “what is APR?”, it’s time to explain APY. APY refers to the total amount of interest you earn on a deposit account each year. You may not think of yourself as a lender, but if you have a deposit account, you are. The bank is essentially paying you for lending them money. Bank accounts that are often associated with an APY include:

• Savings accounts
• Money market accounts
• Certificates of deposit (CDs)

APY is based on an account’s interest rate, and it also factors in how often the interest compounds. Pritchard says one of the big differences between APY and APR is that APY takes compounding into account. (APR only shows the annual interest on an account, not whether the interest compounds or not.)

If you’re trying to answer the “what is APY?” question, understanding how compounding works is key. On some deposit accounts, interest compounds daily, meaning interest gets added to your account’s principal balance one day, and the next day the interest rate applies to that new principal balance. With other deposit accounts, interest may compound monthly, quarterly, or annually. The compounding effect of APY can help you accumulate wealth faster because you are effectively earning interest on your interest. Nice, right?

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For example, if you open an online savings account with a 2.10% APY, interest compounds daily and you deposit $15,000, after five years you’ll have earned a total of $1,644 in interest.¹ Your total interest earned each year would be as follows:

• 1 year: $315
• 2 years: $637
• 3 years: $966
• 4 years: $1,301
• 5 years: $1,644

“The magnitude of difference between APR and APY grows with more compounding periods,” Goodge says. “The only way APR and APY would be the same is if you were only getting paid or owed interest once per year,” Goodge says.

What to know when comparing APYs

Once you understand “what is APY?”, it’s time to compare the APY on different accounts to help you determine how much money your savings can earn over time. If the numbers start to make you dizzy, a savings calculator can come to the rescue. The Discover® savings calculator, for example, can help you determine how much interest you’ll earn each year based on APY, your starting balance, and for how long you plan to save.

When shopping around for a new account, don’t call it quits after comparing only the APY. While it’s a helpful indicator of the returns you’ll get, the APY won’t take potential fees into consideration.

“Minimum balance fees, or any type of activity-related fees, like ATM withdrawals, could eat into the interest you earn,” Pritchard says. “A higher APY might not be worth it if you’re going to pay fees.”

Taking the time to learn about different types of bank accounts that don’t charge fees—or even banks without monthly fees—could help you maximize your interest earnings. An online savings account from Discover, for example, has no monthly fees for maintenance and no balance requirement.

What’s the big difference between APR and APY?

When exploring new financial accounts, APY will be a factor when comparing different types of savings accounts, while APR will impact your terms on credit. You can think of the interest rate as a starting point for comparison as you shop for savings and credit options, as long as you keep in mind all of the variables and differences between APY and APR.

So, now you know that APR applies to your borrowing and APY applies to your saving. But do you know what kind of saver and spender you are? Take our money personality quiz to find out. 

¹ Assumes principal and interest remain on deposit and interest rate and APY do not change for one year. The values shown are for illustrative and informational purposes only and may not apply to your individual circumstances.

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The information provided herein is for informational purposes only and is not intended to be construed as professional advice. Nothing contained in this article shall give rise to, or be construed to give rise to, any obligation or liability whatsoever on the part of Discover Bank or its affiliates.