APR vs. APY

APR is the yearly cost of borrowing, expressed as a simple rate before compounding. APY is the yearly return on savings, expressed after compounding is added in. Same arithmetic family, opposite sides of the ledger — and the gap between the two is where banks and lenders quietly make money.

Federal law forces lenders to disclose APR on loans (Truth in Lending Act) and forces banks to disclose APY on deposits (Truth in Savings Act). The two regimes exist precisely so that consumers can compare apples to apples within a category — APR to APR for loans, APY to APY for savings accounts.

APR (Annual Percentage Rate) is the yearly cost of a loan including the stated interest rate plus most required fees, expressed as a single percentage. It does not include compounding within the year. On a mortgage, APR typically rolls in origination fees, discount points, and mortgage insurance — which is why the APR on a mortgage is usually a touch higher than the headline interest rate.

On a credit card, APR is the annual rate applied to your balance. If your card has an 18% APR and you carry a balance, the issuer divides that by 365 to get a daily periodic rate and charges it against your average daily balance. Pay the statement in full each month and you owe zero interest, regardless of APR.

Different APRs on the same card: purchase APR, balance transfer APR, cash advance APR, and penalty APR. Cash advances usually start accruing interest the day you take the money — there is no grace period. The penalty APR (often near 30%) kicks in if you miss payments and can stick for months.

APY (Annual Percentage Yield) is the effective yearly return on savings after compounding. It answers: if I leave $1 in this account for a year, how much will I actually have? Two accounts can advertise the same nominal interest rate and still produce different APYs depending on how often interest compounds — daily, monthly, quarterly, or annually.

The formula: APY = (1 + r/n)^n − 1, where r is the nominal annual rate and n is the number of compounding periods per year. A 5% nominal rate compounded monthly produces an APY of about 5.12%. Compounded daily, about 5.13%. The difference is small at low rates and small balances, but real on six-figure deposits over decades.

By law, U.S. banks must quote savings accounts, money market accounts, and CDs in APY — so you can compare two accounts by looking only at the APY number, no compounding math required. If a bank quotes you a 'rate' without saying APY, ask.

Take a credit card with an 18% APR. Because interest compounds daily, the effective annual rate you actually pay if you carry the balance for a full year is closer to 19.7% — that is the card's true APY from the issuer's perspective. Lenders are required to advertise the lower number (APR); banks are required to advertise the higher number (APY). That regulatory asymmetry is deliberate: it always shows consumers the less attractive figure for the side of the transaction they are on.

On a mortgage, APR is usually higher than the note rate because it bakes in fees. On a credit card, APY is higher than APR because of compounding. Same word family, opposite directions.

Comparing loans: line up APR to APR. A 6.5% mortgage with $4,000 in fees and a 6.75% mortgage with no fees may have nearly identical APRs — that is the number to trust, not the headline rate. For short holding periods, the lower-fee option often wins even if its APR is slightly higher, because you never recoup the upfront fees.

Comparing savings: line up APY to APY. A 'high-yield' savings account at 4.40% APY beats a 4.35% APY account regardless of compounding frequency, because APY already accounts for that. Watch for promotional rates that revert to a much lower 'standard' APY after a few months.

CDs: compare APY and the term together. A 12-month CD at 4.8% APY beats a 6-month CD at 5.0% APY for most savers, because the 6-month rate may not be available when you go to renew. Always check the early-withdrawal penalty — it is usually quoted in months of interest.

Carrying a credit card balance is the most expensive form of consumer borrowing in normal life. A $5,000 balance at 22% APR, paying only the minimum, takes more than 9 years to clear and costs over $6,000 in interest. That number uses APR; the issuer's effective APY on you is even higher.

Leaving cash in a 0.01% APY checking account during a 5% APY environment costs roughly $500 a year per $10,000 sitting idle. The bank earns the spread between what it pays you and what it lends out — the entire business model of a bank is the gap between APY paid and APR charged.

The single highest-leverage move most households can make is closing both gaps: pay down high-APR debt aggressively and move idle cash to a high-APY account. The combined improvement often exceeds anything an investment portfolio is likely to add in the same year.