APR vs. APY: What Are The Differences?

August 8, 2024

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If you’ve ever worked with a bank to borrow money or open a savings account, you’re probably familiar with the terms APR and APY. While both are related to interest rates, they’re not the same thing.

APR comes into play when you borrow money – it reflects the interest, costs, and fees you’re expected to pay on a loan over the course of a year. On the other hand, APY applies when you put money into a deposit account, and it shows the amount of interest, including compounding, you could earn in a year.

Let’s take a closer look.

What is APR?

APR stands for annual percentage rate, and it’s a number you’ll want to pay attention to whenever you borrow money from a financial institution – whether through a loan or credit card. That’s because the APR helps you understand the total cost of borrowing that money, which can include the interest rate as well as any other related fees and costs.

Many people tend to use the terms APR and interest rate interchangeably, but it’s important to know that those two numbers aren’t always going to be the same – especially when we’re talking about a mortgage or any type of a personal loan.

When you take out a mortgage, for example, the interest rate simply tells you how much it costs to borrow that sum of money, but it doesn’t include any other fees or costs associated with securing the loan. This is when you have to look at the APR, which includes the interest plus any loan-related fees or costs (e.g., broker fees). So that’s why the APR is usually higher than the interest rate when we’re looking at the details of a loan.

However, sometimes the APR and interest rate can be identical and used interchangeably. That’s usually the case when we’re talking about credit cards. But be aware that a credit card could offer different APRs depending on how you’re using the card. For example, a credit card can charge a different APR for purchases, balance transfers, and cash advances.

Also, keep in mind that credit card APRs are typically variable, which means the rate you have one month may not be the rate you have the next month. Not sure about the APR rules for your credit card? Review your card disclosure page for details.

Why is APR important?

If you’re applying for a loan, the APR can help you figure out how much you can expect to pay in interest and fees over the term of your loan. When choosing between your loan options, a good starting point is to compare the APR offers.

Generally speaking, the lower the APR, the better, as it means you won’t pay as much in interest and fees. APR offers can vary depending on the type of loan, your lender, and your credit history. Borrowers with a solid credit history are more likely to receive favorable interest rates.

Always review the terms of the loan carefully. For example, is it a fixed loan or adjustable-rate loan? What happens if you make a late payment or default? In short, whenever you plan to take on debt, be sure to understand the total cost of borrowing and your payment responsibilities.

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1. Find the Periodic Rate, which is the compounding frequency

The simplest way to find this is to scan your credit card statement look for the table also known as the “Schumer Box”, which summarizes the cost of a credit card. In this case, you’re looking for how the card computes your balance or the “finance calculation method.” Many credit cards charge interest using the average daily balance; this means they charge interest daily (the daily periodic rate). If there’s no grace period – also in the Schumer Box – this means interest starts building immediately. Grace periods are common. They are the amount of time between the billing cycle and the payment due date. You won’t pay interest if you pay in full on time, and have a grace period.

2. Divide the APR by the periodic rate

Since the APR (also in the Schumer Box) is an annual figure, you’ll want to divide it by the finance method. If it’s daily, you’ll divide the APR by 365. If it’s monthly, by 12.

3. Calculate your average daily balance

This is a little more involved because you need a record of how much credit you’ve used at the end of each day of a billing period. (Apps that track your purchase history can be a big help here). For a month with 30 days, this means adding the balance at the end of each of these days and dividing them by the number of days in the billing cycle.

4. Complete the calculation

Multiply the average daily balance (step 3) by the periodic rate (step 2). Then multiply this result by the number of days in the billing cycle.

What is APY?

APY or annual percentage yield applies when we’re looking at deposit accounts that generate interest earnings, including high-yield savings accounts and certificates of deposit (CDs). If you compare the APY and interest rate from your savings account side by side, you’ll notice that the APY is usually slightly higher. This is because APY reflects the interest rate you earn as well as the impact of compounding on your savings in a year. You can learn more about compound interest in our article here.

Good to know: APYs can be fixed or variable depending on the type of savings vehicles you’re considering. For example, traditional savings accounts usually come with a variable APY, where the interest rate can go up or down. Many CDs come with a fixed APY, where you can lock in a predetermined rate for your CD term.

Why is APY important?

When shopping for a savings account, the APY can tell you how much you could earn in interest in a given year. Generally, the higher the APY, the better. Your earnings will also depend on the compounding frequency (daily, monthly, or annually as determined by your bank). Keep in mind that the more often it compounds, the faster your money could grow.

In addition to comparing the APY offers, don’t forget to take a look at any account fees that may apply. Remember, the more you have to pay in fees, the less you can put towards your savings goals.

Bottom line

To recap, when you’re borrowing money, like taking out a personal loan or using a credit card, you’re dealing with APR. On the flipside, when you’re saving money in a deposit account, whether it’s a high-yield savings account or CD, you’re looking at APY. Keep that important distinction in mind when you’re shopping for a personal loan or savings account.

Understanding the differences between APR and APY can help you make informed decisions about your money.

This article is for informational purposes only and is not a substitute for individualized professional advice. Articles on this website were commissioned and approved by Marcus by Goldman Sachs®, but may not reflect the institutional opinions of The Goldman Sachs Group, Inc., Goldman Sachs Bank USA, Goldman Sachs & Co. LLC or any of their affiliates, subsidiaries or divisions. Information and opinions expressed in this article are as of the date of this material only and subject to change without notice.