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APR vs APY: two rates that answer different questions

Banks quote APR when you borrow and APY when you save, and the two are built differently. Comparing one against the other compares nothing.

Published by Eigenlabs · Last reviewed · 2 min read · 2 sources · Editorial method · AI use

See compounding in the compound interest calculator
01

APR: the cost of borrowing

The CFPB describes APR as a broader measure than the interest rate.

For a mortgage, the CFPB explains that the interest rate is the yearly cost of borrowing the money, while the annual percentage rate also reflects points, broker fees, and other charges paid to get the loan — which is why the APR is usually higher than the rate. On a Loan Estimate the interest rate is on page 1 under Loan Terms, and the APR is on page 3 under Comparisons.

02

APY: what savings earn

Regulation DD defines it for deposit accounts.

Under the federal Truth in Savings rules, the annual percentage yield measures the total interest paid on an account based on the interest rate and how often it compounds, expressed as an annualized rate on a 365-day year. It excludes bonuses and interest that depends on events that may not happen. That is what makes APYs comparable between banks.

03

Why APY is higher than the rate

Compounding pays interest on interest.

A 4.00% rate compounded monthly produces an APY of about 4.07%, because each month’s interest earns interest for the rest of the year. Compounded daily, the same 4.00% gives about 4.08%. The more often interest compounds, the further the APY moves above the stated rate — the compound interest calculator shows the effect over longer periods.

04

Compounding works against a borrower too

The same arithmetic, pointed the other way.

If a 24% annual rate were compounded daily, the effective yearly cost would be about 27.1%. APR as disclosed for loans is not built as an effective compounded rate, so do not read a loan APR and a savings APY as the same kind of number.

05

Comparing offers correctly

Match the measure to the product.

  • Savings accounts and CDs: compare APY with APY.
  • Mortgages and loans: compare APR with APR for loans of the same type — the CFPB warns that the APR of an adjustable-rate loan does not reflect its maximum rate, and that closed-end loan APRs include fees while home equity line APRs do not.
  • Never compare a loan APR with a savings APY.

2 SOURCESSource ledger

Check the basis.

  1. 01Consumer Financial Protection Bureau — What is the difference between a mortgage interest rate and an APR? ↗
  2. 02Consumer Financial Protection Bureau — Appendix A to Part 1030 — Annual Percentage Yield Calculation ↗

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QUESTIONS THIS ANSWERS

Questions this answers

  • What is the difference between APR and APY?
  • Why is APY higher than the interest rate?