APR vs APY: Understand the Difference Before You Borrow or Save
APR and APY are not interchangeable. A clear explanation with a worked compounding example and the questions worth asking a bank.
Key takeaways
- APY includes the effect of compounding over a year; a quoted annual interest rate may not.
- Borrowing APR may include certain costs, so comparing loans requires looking at the applicable disclosure.
- Use the same time period, product terms and assumptions when comparing quoted rates.
APR and APY answer different questions
Annual percentage yield (APY) describes how much a deposit earns over a year after taking compounding into account, assuming the rate and other conditions stay unchanged. It is widely used in U.S. deposit-account comparisons. Annual percentage rate (APR) is commonly used for the annualized cost of borrowing. The fees included in APR depend on the financial product and jurisdiction.
Some institutions also quote a nominal annual interest rate. A nominal rate is not automatically an APY, because compounding can change the effective annual yield. It is important to identify which rate the bank actually shows, rather than comparing percentages with different definitions.
A worked example: 5% with monthly compounding
Imagine a savings balance with a nominal annual interest rate of 5%, compounded every month. The monthly rate is 5% divided by 12, or approximately 0.4167%. The effective annual yield is (1 + 0.05/12)^12 − 1, which equals approximately 5.116%.
On a hypothetical $10,000 balance with no contributions or withdrawals, that would be about $511.62 of interest over a year, not $500. This simplified calculation assumes the same balance and fixed rate throughout the year and ignores taxes and any account conditions.
Why borrowing APR requires careful reading
For a loan, APR can incorporate certain financing costs beyond the stated interest rate. A loan advertising a low interest rate may still be expensive if it has substantial fees. APR definitions and disclosure rules are not identical everywhere.
Before comparing loans, look at the lender’s written APR disclosure, total amount financed, total repayment, term length, prepayment policy and whether the interest rate can change. Two loans with the same APR but different terms can still have different monthly payments and total interest.
A practical rate-comparison checklist
Use this sequence when reviewing savings products or loans. Avoid relying on the biggest number in a promotional banner without reading its conditions.
- For savings: confirm whether the quoted figure is APY, nominal interest or another measure.
- Find out whether the rate is promotional, variable, tiered or subject to balance rules.
- For loans: compare APR, fees, total repayment and term rather than the payment alone.
- When comparing internationally, check local regulatory definitions and currencies.
Try the numbers
Our compound interest calculator illustrates the effect of a fixed rate, recurring deposits and time. It uses monthly compounding and is not a substitute for a provider’s official APY calculation. The loan payment calculator can help show the trade-off between payment size and repayment term, but it does not include loan fees.
Sources and further reading
For additional context, these official or institutional resources can help you verify important definitions and rules. Their inclusion does not mean they reviewed this article.
For a related example, explore our financial calculators. You can also read our editorial policy to understand our sourcing and corrections approach.