APR vs. APY: Understanding credit card interest rates

The Bankrate promise
At Bankrate we strive to help you make smarter financial decisions. While we adhere to strict , this post may contain references to products from our partners. Here's an explanation for . The content on this page is accurate as of the posting date; however, some of the offers mentioned may have expired. Terms apply to the offers listed on this page. Any opinions, analyses, reviews or recommendations expressed in this article are those of the author’s alone, and have not been reviewed, approved or otherwise endorsed by any card issuer.
When comparing credit cards, you may encounter the terms APY and APR. While these acronyms look similar, they are very different in the way they describe interest. For starters, annual percentage rate (APR) refers to interest owed while annual percentage yield (APY) shows interest earned.
Here’s a guide on APR and APY, how they work and how they are different.
What is APR?
APR refers to the amount of interest you’ll pay annually on a loan or credit card. That doesn’t mean you’ll pay your credit card or loan once per year—typically, you’ll make a monthly payment.
The Truth in Lending Act, which protects consumers against unfair lending practices, requires lenders to disclose the APR upfront. That’s because APR is meant to show the actual annual cost of borrowing money, which includes lender fees and other charges in addition to the interest rates. For example, mortgage loans often come with origination fees, points and other charges that the APR considers.
But, when it comes to credit cards, the APR and the interest rate are the same. While your card may come with an annual fee or charges for late payments, balance transfers, and the like, card issuers generally don’t include these fees in the APR. It’s simply too difficult for credit card companies to predict which fees you will incur or how often you will incur them.
How does APR work?
As mentioned, APR is the simple interest rate charged to a borrower over a year. So, if you purchase a $1,000 laptop computer using a credit card with a 20 percent APR, your account balance will be $1,000, and you’ll be charged $200 in interest in 12 months, which equals $16.66 per month.
However, you’ll likely end up paying more because APR doesn’t show the effect of compounding interest. Most credit card issuers compound the interest charges daily if your account carries a balance. The issuer calculates your daily interest rate by dividing your APR by 365.
That means interest is added to your account every day based on its average daily balance. The greater your balance grows, the more interest is added to your balance each day. Conversely, the more your balance decreases, the less interest is added to your balance.
Fortunately, you can usually avoid paying interest altogether on credit card purchases by paying your account balance in full each month by the due date. Another way to bypass interest charges is to transfer your debt to a balance transfer credit card with a 0 percent APR for a specified period. Further, a credit card with a 0 percent introductory APR may be worth considering if you have larger purchases in mind and want to avoid interest while you pay it off.
What is APY?
While APR is used to describe the interest you’ll pay on loans and credit cards, APY refers to the interest you’ll earn on your savings over a year. The term APY—often referred to as earned annual rate or EAR—is commonly used by banks and investors to state your rate of return on savings and deposit accounts. In this case, you are the “lender” and the APY lets you know how much your money is earning in interest.
Unlike APR, APY takes compound interest into account. However, APY doesn’t include any fees because that would drag down the return rate, making it harder for banks and financial institutions to attract more investors.
How does APY work?
APY considers how often your savings or investment account compounds with this formula:
APY= (1 + r/n )n – 1.
“R” refers to the stated annual interest rate, and “n” is the number of compounding periods each year.
But, if you don’t want to run the math yourself, a compound interest calculator could save you time.
A savings account or deposit account may compound daily, monthly, quarterly or annually. As a rule, the more often your account adds compound interest, the faster your investment grows. That’s because each time your account compounds interest, the earned interest is added to the principal amount, and future interest payments are calculated on the larger principal balance.
If you’re comparing savings or investment accounts, it pays—quite literally—to compare their APYs and not just their interest rates. It may appear that one account is a better investment because its interest rate is higher than another account. However, if that second account compounds more frequently, it may outgrow the first account over the year.
APR vs. APY
APR and APY both measure interest, but they have different uses. APR describes the interest you owe on a credit card or loan, while APY measures the interest you earn from a savings or an interest-earning deposit account, such as a savings account, CD or money market account.
The most significant difference between APR and APY is that APR doesn’t take compounded interest into account, while APY does. APY refers to your deposit’s interest plus compound interest. By contrast, the APR value for installment loans only includes the interest plus potential fees. There is no difference between the APR and the interest rate for credit cards.
The bottom line
Whether you’re comparing credit card offers or establishing a savings account, having a firm understanding of APR and APY can help you make more informed decisions with your money. And if you need help, Bankrate has many credit card calculators to assist you.
If you’re considering a credit card offer, pay attention to the APR—a lower rate means you’ll pay less interest. Remember, annual fees and other charges are not included in credit card APRs, so make sure to read the fine print to determine if fees are likely to offset the card’s benefits.
The opposite is true with APY. The higher the rate, the more interest you’ll earn on your deposit. And if you’re comparing savings accounts, pay close attention to the frequency that your interest compounds to better understand how much your money will earn.
Related Articles



