APR vs. APY: What’s the Difference and Why Does It Matter?

When it comes to comparing financial products—whether you’re shopping for a mortgage, auto loan, savings account or certificates of deposit - you’ll often see two important acronyms: APR or APY. While they might look similar, these terms represent two very different concepts. Understanding the difference can help you make smarter borrowing and saving decisions.

But before diving into annual percentage rates versus annual percentage yields, let’s break down the one thing that binds them: Interest.

What Is Interest and Why It Matters

Interest can be one of two things: Either the cost of using someone else’s money or the reward for letting someone use yours. It’s calculated as a percentage of a loan or deposit balance.

• For borrowers, a lower interest rate means paying less over time.
• For savers and investors, a higher interest rate means earning more on your deposits.

Whether you’re comparing credit cards, personal loans or deposit accounts like checking, savings or CDs, knowing how APR and APY are calculated can make a big difference in your financial outcomes.

Understanding APR: The Cost of Borrowing

APR, or annual percentage rate, represents the true annual cost of borrowing money. It includes not just the loan’s interest rate but also other costs like lender fees, closing costs or certain service charges.

Key Takeaways About APR

• Reflects the total cost of credit over a year, expressed as a percentage.
• Includes certain fees so it’s typically higher than the interest rate alone.
• Helps compare loans from different lenders on an apples-to-apples basis.

For example, if two lenders offer the same interest rate on a mortgage, but one charges higher origination or closing fees, that lender’s APR will be higher.

Introductory APRs

Some lenders advertise a promotional or introductory APR that applies for a set period. While tempting, it’s important to check:

• How long the introductory rate lasts
• What the rate increases to afterward
• Any conditions or balance transfer fees involved

Being aware of these details helps you avoid surprise costs later in the loan’s life.

Understanding APY: The Return on Your Savings

APY, or annual percentage yield, measures how much you earn on a deposit account, such as a savings account, money market, CD or even some checking accounts, over one year—including the effect of compound interest.

How Compound Interest Works

Compound interest means you earn “interest on your interest.” When earned interest is added back to your balance, future interest calculations are based on the new, higher total.

For instance, if you deposit $10,000 in a CD:

• Bank A compounds interest monthly.
• Bank B compounds interest quarterly.

Even if both offer the same stated rate, Bank A’s APY will be higher because the interest is compounded more frequently, so the balances rises faster.

APR vs. APY: The Key Differences

Understanding these differences ensures you’re making the most informed decision - whether you’re borrowing or saving.

Putting It All Together

Both APR and APY are calculated annually but represent very different perspectives:

• APR tells you how much a loan costs.
• APY tells you how much your money earns.

When comparing offers, always read the fine print and look beyond the headline rate. Fees, compounding frequency and rate changes can all influence your true financial outcome.

Pro Tip: If you’re opening a new savings account, ask your banker how often interest compounds and whether there’s a minimum balance to earn the advertised APY. The more you know about how these percentages are calculated, the more confidently you can choose products that align with your goals.

OMB and its affiliates do not provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decision.