What is the difference between APR and APY?

Annual percentage rate expresses a yearly rate without accounting for compounding within the year, and by law it must include certain fees on loans, which is why APR on a mortgage exceeds the stated interest rate. Annual percentage yield includes the effect of compounding, showing what you actually earn over a year if interest is left to accumulate. A 5 percent nominal rate compounded monthly produces an APY slightly above 5.1 percent, and compounded daily slightly higher still. The gap widens as rates rise, which is why the distinction matters more in high-rate environments.

The convention is not accidental. Lenders quote APR on credit products and banks quote APY on deposits because each presents the institution's offer favorably, and both are regulated: Truth in Lending requires APR disclosure on loans and Truth in Savings requires APY on deposit accounts, specifically so that consumers can compare offers on a consistent basis within each category. Comparing a loan APR against a savings APY directly is comparing two differently constructed numbers, which is worth remembering when weighing whether to pay down debt or save.

One important limitation on credit cards. The APR shown is nominal and does not reflect that most cards compound daily on carried balances, so the effective annual cost of carrying a balance exceeds the stated APR. A card advertising 24 percent costs closer to 27 percent effectively when compounded daily. Cards also carry different APRs for purchases, balance transfers, and cash advances, with cash advances typically the highest and usually accruing interest from the transaction date with no grace period. Reading which APR applies to which activity, and whether a promotional rate reverts and when, is where the actual money is, rather than in the headline number.