Interest Rates: APR vs APY
Understand the difference between APR and APY and how they affect your money
APR VS APY
APR (Annual Percentage Rate)
The annual interest rate without accounting for compounding. It's the simple interest rate you see advertised. APR tells you the basic interest rate, but doesn't show the full cost when interest compounds.
APY (Annual Percentage Yield)
The effective annual rate that accounts for compounding. APY shows the actual amount you'll pay or earn over a year, including the effect of compounding interest.
Key Difference
APR = Simple interest rate (what you see advertised)
APY = Effective rate with compounding (what you actually pay/earn)
For savings: APY is higher than APR (you earn more)
For loans: APY is higher than APR (you pay more)
APR TO APY CALCULATOR
Future Value Calculation
REAL-WORLD APR VS APY
Savings Account (Monthly Compounding)
APY accounts for monthly compounding, so you earn slightly more than the stated APR
Credit Card (Daily Compounding)
Daily compounding means you pay interest on interest, making the effective rate higher
CD (Quarterly Compounding)
Less frequent compounding means smaller difference between APR and APY
Loan (Simple Interest)
Simple interest loans don't compound, so APR and APY are the same
HOW COMPOUNDING AFFECTS INTEREST
Compounding means earning (or paying) interest on interest. The more frequently interest compounds, the greater the difference between APR and APY.
Example: $10,000 at 5% APR
| Compounding Frequency | APY | Value After 1 Year | Difference |
|---|---|---|---|
| Annually (1x) | 5.00% | $10,500.00 | $0.00 |
| Quarterly (4x) | 5.09% | $10,509.45 | $9.45 |
| Monthly (12x) | 5.12% | $10,511.62 | $11.62 |
| Daily (365x) | 5.13% | $10,512.67 | $12.67 |
Key Insight: More frequent compounding = higher APY = more money earned (or paid)
WHEN TO USE APR VS APY
Use APR When:
- Comparing loan rates (standardized comparison)
- Understanding the base interest rate
- Simple interest calculations
- Legal disclosures and regulations
Use APY When:
- Comparing savings account returns
- Understanding actual cost of borrowing
- Calculating real investment returns
- Making financial decisions
💡 Important:
Always compare APY to APY when making financial decisions. Comparing APR to APY is like comparing apples to oranges. For savings, higher APY is better. For loans, lower APY is better.
FIXED VS VARIABLE INTEREST RATES
Fixed Interest Rate
The interest rate stays the same for the entire loan or investment term.
- Predictable payments
- Easy to budget
- Protection if rates rise
- No surprises
- May miss out if rates fall
- Often higher initial rate
- Less flexibility
Best for: People who want stability and predictability
Variable Interest Rate
The interest rate can change over time based on market conditions or an index.
- Lower initial rate
- Can benefit if rates fall
- More flexibility
- Unpredictable payments
- Can increase significantly
- Harder to budget
- Risk of payment shock
Best for: People comfortable with risk and rate fluctuations
TIPS FOR UNDERSTANDING INTEREST RATES
✅ Always Compare APY to APY
When comparing financial products, use APY for accurate comparisons. APR can be misleading when compounding frequencies differ.
✅ Read the Fine Print
Check compounding frequency, fees, and terms. A lower APR with high fees may cost more than a higher APR with no fees.
✅ Understand Compounding
More frequent compounding means higher APY. Daily compounding is better for savings, worse for loans.
✅ Consider Total Cost
Look beyond the interest rate. Consider fees, penalties, and total amount paid over the life of the loan or investment.
✅ Ask About Rate Changes
For variable rates, understand when and how rates can change. Know the caps and limits on rate increases.
✅ Use Calculators
Use online calculators to see the real cost or return. Small differences in rates can mean thousands of dollars over time.