Annual percentage rate (APR) and annual percentage yield (APY) both relate to interest on financial products like loans, credit cards, and bank accounts, so it’s easy to confuse them. But they’re not the same. In fact, you want one of these numbers to be high and the other to be low. Here’s more about APR vs. APY, and why it matters for your finances.
What is APR?
APR, or annual percentage rate, is the interest rate you pay to borrow money, plus any loan fees that may apply, like closing costs on a mortgage or auto dealer charges on a car loan. A product’s interest rate tends to be lower than its APR, since the interest rate doesn’t include fees. A low APR means you’ll spend less to borrow money, and a high APR means you’ll spend more.
What is APY?
APY, or annual percentage yield, is the annual interest rate you earn on accounts that pay interest, like savings accounts, and certain investments, like certificates of deposit (CDs). The higher the APY, the more interest you earn; the lower the APY, the less interest you earn. For example, if you have a savings account with a $10,000 balance and a 3.75% APY, you’d earn $375 in interest over the course of a year (assuming interest compounds yearly). If the APY were 4.25% instead, you’d earn $425 in interest on that $10,000 by the end of the year.
APR vs. APY: Similarities and differences
APR and APY tell you about interest in 2 distinct ways. Let’s take a closer look at how they’re alike and different.
They apply to different products
APRs apply to lending products like:
- Mortgages
- Personal loans
- Student loans
- Auto loans
- Credit cards
- Home equity lines of credit (HELOCs)
APYs apply to banking and investment products like:
- Savings accounts
- Checking accounts
- CDs
- Money market accounts
- Cash management accounts
You want a low APR and a high APY
When shopping for a loan, you’ll ideally want the lowest possible APR. A lower APR means paying less in total interest and fees. But when it comes to interest-earning accounts like savings accounts and CDs, the highest possible APY will earn you the most interest on your cash.
Both APRs and APYs can fluctuate
Unless your rate is fixed, both APRs and APYs can be variable, meaning they could change while you hold the loan or the account. Both are indirectly linked to the federal funds rate, which is set by the Federal Reserve. When the Fed increases or decreases that rate, many APRs and APYs could follow suit.
Interest on both can compound
Compound interest is when you are charged or paid interest on not just the amount you’ve borrowed or deposited but also on interest that’s already accrued. This can either work for you or against you. If you’re borrowing money, compound interest can significantly increase your total costs, especially with credit cards if you carry a balance from month to month. With a savings or investment account, though, compound interest can help your money grow at a faster pace.
Only APRs account for fees
While it’s a common misconception, the main difference between APR and APY isn’t about compounding interest—it’s about fees. Both APR and APY actually do account for how frequently interest is compounded, but only APR accounts for fees.
APR is designed to give you a more complete picture of the annual cost of borrowing. It includes not only the interest charges but also fees associated with the loan, such as origination fees or closing costs. This is why a loan’s APR is often higher than its advertised interest rate.
On the flip side, APY is designed to show you the total amount of interest you will earn in a year. APY reflects the stated interest rate plus the effect of compounding, but since savings products typically don’t have fees, what you see is what you get with APY.
APR vs. APY and you
Since you can expect APR and APY to show up across financial products, here are some questions to ask yourself to help you make well-informed saving and borrowing decisions.
Am I getting the best rate?
APRs and APYs can vary based on the lender and potentially based on your credit health. To increase your chance of getting the lowest possible APR, make sure your credit score is in top shape and compare several lenders’ offerings. To find the best APYs, don’t be shy about shopping around at different financial institutions and considering different kinds of accounts.
Can I increase my APY?
Beyond shopping around, you could increase your APY on CDs and deposit accounts by being flexible. For CDs, which pay a set interest rate in exchange for holding onto your money for a set period of time, APYs tend to vary by term length and deposit amount. APYs on savings and money market accounts can also vary based on the size of the opening deposit. If you’re willing to chip in more upfront or tie up your money for the CD duration that pays the best rate, you could earn more.
Will my APR or APY change?
It depends on the financial product. A loan with a fixed-rate APR won’t change, but a credit card with a variable APR will. Similarly, APYs on savings accounts are variable, but most CDs offer fixed rates. If you’re using a credit card with a low introductory APR, it’s important to know what the regular APR is and when it kicks in.
What APR will I pay?
Your lender is obligated to disclose your APR. Credit cards have different APRs for different uses, including cash advance APRs and regular purchase APRs. Review your cardholder agreement to know which APR applies to different transactions.