What Is the Difference Between APR and APY?

Banks and other financial institutions have many specialized terms to describe their services. Two acronyms you may see as you deposit money or take out loans are APR and APY. By learning the difference between these terms, you can have more confidence in your money management because you see how they may impact your finances.

What Is APR?

APR stands for annual percentage rate. The term refers to the interest you pay for borrowed money, including any additional fees. You will often see it applied to loans or credit cards. Federal laws require lenders to share the APR with consumers so that they can compare rates and find the best one for their situation. For APR, seeking the lowest rate is typically the best course of action because it means you pay less interest.

The annual percentage rate includes more than just your interest rate. It also reflects:

Processing fees: A one-time fee for processing your home equity or personal loan application.
Origination points: Money paid to the lender as a fee for the evaluation, processing and approval of a mortgage loan.
Discount points: An opportunity for buyers to lower their mortgage interest rate by paying upfront.
Mortgage broker fees: A commission paid to a broker, usually by the lender, which accounts for their services of finding and arranging a loan for the borrower.

Your APR also includes any additional charges you may pay to get the loan, meaning it is usually higher than your interest rate. You can use online tools to calculate your APR for things like mortgages.

What Is APY?

APY stands for annual percentage yield. It refers to the percentage of interest you earn on interest-bearing checking accounts, savings accounts, money market accounts or certificates of deposit. Like APR, federal laws require financial institutions to disclose their rates to allow you to compare when shopping for deposit accounts. With APY, you want a higher rate because it means you earn more money.

APY calculates how compounding interest impacts the interest rate over a year. With compounding interest, the interest earned during a set period is added to the account, increasing the balance that is earning interest during the following period. The compounding of interest increases your savings faster. For example, if you have a 12-month certificate of deposit that compounds interest monthly, it means that at the end of the month the interest you earned for the month will be added to your balance. You will then earn interest the next month on the higher balance that includes the interest you earned.

APR vs. APY — How They Work

APR and APY produce a more accurate idea of spending or saving than you get with interest rates alone. Both include additional factors like APR discount or origination points and APY compound interest.

With APR, your interest paid will be lower than the interest you would earn on the same APY. It works this way because, with a loan, you slowly decrease the amount you owe through regular payments, meaning there's a smaller balance to pay interest on. With APY, you gradually increase the amount you earn due to interest, meaning you have a larger balance to earn interest on.