What each one means
Both APR and APY describe a yearly interest rate, but they account for compounding differently:
- APR — annual percentage rate. The nominal yearly rate, ignoring how often interest is added. A 12% APR is simply 1% per month stated as a yearly figure.
- APY — annual percentage yield. The effective yearly rate once compounding is included. Because each period's interest itself earns interest, APY ends up higher than the matching APR.
APY = (1 + APR ÷ n)n − 1
where n is the number of compounding periods per year. The more often interest compounds, the larger the gap between APR and APY.
A worked example
Take a 12% APR compounded monthly (n = 12):
Monthly rate: 12% ÷ 12 = 1% per month.
APY: (1 + 0.01)¹² − 1 = 1.1268 − 1 = 12.68%.
Takeaway: the same 12% APR actually earns (or costs) 12.68% over a full year once compounding is counted.
Which rate do banks quote?
| Product | Rate disclosed | Why |
|---|---|---|
| Savings, CDs, money market | APY | Truth in Savings Act — lets savers compare real returns. |
| Credit cards, loans, mortgages | APR | Truth in Lending Act — standard cost-of-credit figure. |
Why the law splits them: deposits must be advertised by APY so the figure already includes compounding and savers can compare accounts fairly, while loans use APR as the cost-of-credit measure. The legal definitions sit in the CFPB's Regulation DD (Truth in Savings) for APY and Regulation Z (Truth in Lending) for APR.
Reading rates in real life
- Saving? Compare APY between accounts — it already reflects compounding, so a higher APY genuinely earns more.
- Borrowing? APR is the headline, but if the card compounds daily your effective cost is the APY-equivalent, which is slightly higher. Paying the balance in full each month avoids interest entirely.
- Comparing apples to apples? Convert everything to APY before judging which is cheaper or more rewarding.