APR vs. APY: What's the difference (and why does it matter)?

If you spend any time researching loans or savings accounts, you’ll see the terms “APR” and “APY” everywhere. Because these acronyms sound so similar, it’s easy to confuse them.

APR and APY are related — they’re both representations of interest rates. They’re important numbers to look for when you’re shopping for a bank account or a loan, but they have distinct meanings. As a borrower or saver, knowing the difference between APY vs. APR — and why it matters — is crucial.

What is APR?

A loan’s APR, or annual percentage rate, represents the yearly cost of borrowing, including interest and fees. Because different loans can have varying rates, fees, terms, and payment cycles, knowing a loan’s APR can help you compare it more accurately to other loan offers.

As a borrower, you generally want the loan with the lowest APR you can find. For example, say you’re comparing two loans. One has a lower interest rate, but it comes with an origination fee. The other has a slightly higher interest rate but no fees. Comparing these two loans’ APRs can help you choose the one with a lower yearly cost — which might turn out to be the one with the higher interest rate.

Unlike APY, APR doesn’t account for compounding. Compound interest is calculated both on the original balance and from previously accumulated interest. So, if you take out a loan that charges compound interest (common with mortgages), you may pay more each year than the advertised APR.

Calculating APR

APR is calculated using the following equation:

APR = ((Interest / loan amount) / number of days in loan term) x 365 x 100

If the loan comes with fees, you’d add them to the interest, then continue with the calculation:

APR = ((Interest + fees) / loan amount) / number of days in loan term) x 365 x 100

For example, say you take out a $6,000 personal loan. The lender charges you $800 worth of interest and fees. In this case, your APR would be:

(($800 / $6,000) / 365)) x 365 x 100 = 13.33%

What is APY?

APY, or annual percentage yield, tells you how much your interest-bearing account earns over the course of a year based on the interest rate and frequency of compounding. Similar to APR, APY measures the cost of borrowing. But in this case, the bank is the borrower, and you — the account holder — are the lender. APY represents what the bank pays you over a year in exchange for you “lending” your money.

APY doesn’t take fees or bonuses into account. So if your account charges a monthly fee or provides a sign-on bonus, you won’t see it reflected in the APY.

Unlike APR, APY does account for compound interest. The more frequent the compounding, the faster your money grows.

Read more: What is a good savings account interest rate?

Calculating APY

You can calculate APY with the following equation:

APY = 100 [((1 + interest/principal) (365/days in term)) - 1]

For example, say you put money into an account that advertises $50 earnings during your first year with a deposit of $1,000. Plugging these numbers into the equation above, the APY would be:

100 [((1 + $50/$1,000) (365/365)) - 1] = 5%

APR vs. APY: key differences

APR and APY have similar meanings, but they aren’t the same thing. The following examples illustrate how you might use each to calculate costs and earnings.

Say you’re shopping for a personal loan. You compare options from various lenders to find the lowest rate. You end up taking out a $5,000 loan for 7.50% APR. If you repaid the loan in one year, you’d pay a total of $5,205.45. In other words, you’d repay the loan principal plus $205.45 in interest and fees.

But say, instead, you have $5,000 you want to put into a high-yield savings account. You research different banks and credit unions and find an account that offers an APY of 5% with daily compounding. Assuming you put the $5,000 in the account and don’t touch it for a year, you’d end up with $5,256.34 — your initial investment plus $256.34 in interest.

To recap, the following table shows some of the biggest key differences between APR and APY:

When it comes to similarities, both APR and APY are useful numbers for comparing financial products. Both are a representation of interest rates, but they’re used in different circumstances and have distinct meanings.

Frequently asked questions

What is the difference between APY vs. APR?

APY tells savers how much their money will earn in interest over the course of a year. APR tells borrowers how much a loan will cost them per year, including fees and interest. Both APY and APR are tied to interest rates, but they’re used for different purposes. Only APY takes compound interest into account. The more frequently interest compounds, the bigger the difference between APY and APR.

What does 5.00% APY mean?

If you see a bank advertising an account with 5.00% APY, that means the money you put in the account will earn 5.00% interest per year. For example, if you deposit $10,000 and then leave the account alone, you’ll have earned $512.67 in interest one year later (assuming interest compounds daily).

What is a good APR?

As a borrower, the lower the APR, the better. APR represents the cost you’ll pay to borrow, including interest and fees. The lower the APR, the less you’ll pay. APR also varies by loan type and lender. Shop around and compare rates to find the best APR.

What is a good APY?

If you want to earn more on your savings, a higher APY is better than a low one. The higher the APY, the more your money will earn over the course of a year. Like APR, APY varies by account type and financial institution, so you should shop around to find the best rates.