When comparing credit cards, you may come across the terms APY and APR. Although these acronyms are similar, they describe interest in very different ways. First, the Annual Percentage Rate (APR) refers to the interest you pay, while the Annual Percentage Yield (APY) tells you the interest you earn.
Here we explain how APR and APY work and what the differences are.
What is APR?
When most people see the term APR, they think of the total amount of interest paid each year on a loan or credit card. Interest is one component of APR, but it’s not necessarily the only component.
The Truth in Lending Act, which protects consumers from unfair lending practices, requires lenders to disclose the APR up front. That’s because the APR is intended to show the true yearly cost of borrowing, which includes the interest rate plus lender fees and other charges. For example, mortgages often have origination fees, points and other charges attached to them that the APR takes into account.
But with credit cards, the APR and the interest rate are the same. Cards may have annual fees, late fees, balance transfer fees, etc., but card issuers typically don’t include these fees in the credit card APR because it’s very difficult for issuers to predict which fees you’ll incur and how often they’ll occur.
How does APR work?
As mentioned above, for credit cards, the APR is the simple interest charged to the borrower per year. This means that if you buy a $1,000 laptop using a credit card with a 20 percent APR, you will have a $1,000 account balance and will be charged $200 in interest over 12 months. However, APR doesn’t have the effect of compounding interest, so you may end up paying more.
Most credit card issuers compound interest daily if you have a balance in your account. This means that interest is added to your account every day, based on your average balance. The more your balance increases, the more interest is added to your balance each day. This also means that you end up paying interest on interest. Conversely, the more your balance decreases, the less interest is added to your balance.
Fortunately, you can usually avoid paying interest on credit card purchases by paying your account balance in full by the due date each month. If you want to avoid interest while paying for a big purchase, it might be worth considering a 0 percent introductory APR credit card. Transferring existing debt to a 0 percent introductory APR balance transfer credit card is another way to avoid paying interest for a period of time, but you usually have to pay a balance transfer fee.
What is APY?
While APR is used to describe the amount of interest paid per year, APY refers to the amount of interest earned in one year. Sometimes called the Annual Percentage Rate (EAR), APY is often used by banks and investors to describe the total yield they receive on a savings or deposit account. In this case, you’re the “lender” and APY tells you how much interest your money is earning.
Unlike APR, APY takes compound interest into account, but does not include fees, in part because including fees would lower the rate of return, making it harder for banks and financial institutions to attract more investors.
How does APY work?
APY takes into account how often your savings or investment account grows with compound interest, using the following formula:
Bankrate Insights
Annual interest rate = (1 + r/n)n – 1
“r” refers to the stated annual interest rate and “n” refers to the number of compounding periods each year.
If you don’t want to do the math yourself, you can save time by using Bankrate’s compound interest calculator.
A savings or deposit account may compound interest daily, monthly, quarterly, or annually. As a general rule, the more frequently an account compounds interest, the faster your investment will grow. This is because each time interest is compounded in your account, the interest earned is added to your principal amount, and future interest payments are calculated based on the larger principal balance.
When comparing savings and investment accounts, it’s useful to compare APYs as well as interest rates. At first glance, one account may seem like a better investment because it offers a higher interest rate than the other. But if the other account compounds more frequently, your balance in the other account could exceed the balance in the first account in a year.
APR and APY
APR and APY both measure interest but have different uses: APR represents the interest you earn on credit cards and loans, while APY measures the interest you earn from savings accounts and interest-bearing deposit accounts (such as savings accounts, CDs, and money market accounts).
The biggest difference between APR and APY is that APR does not take into account compound interest, while APY does. APY refers to interest and compound interest on savings. In contrast, the APR value for installment loans only includes interest and potential fees. There is no difference between APR and credit card interest rates.
Some credit cards allow you to deposit your cash back directly into a High Yield Savings Account (HYSA) that is only available to the cardholder. In this case, you should look at both the APR and APY when weighing the pros and cons of applying for a particular card. For example, Apple Card* allows you to transfer your Daily Cash to a HYSA at a 4.40% APY. For your convenience, Apple has combined both the account where your Daily Cash is collected and your Apple HYSA in the same Wallet app. This feature is only available to Apple Card owners and co-owners.
Conclusion
Whether you’re comparing credit card offers or opening a savings account, having a solid understanding of APR and APY can help you make more informed decisions with your money. If you need help, Bankrate has a number of credit card calculators available.
When considering credit card offers, pay attention to the card’s APR. A lower rate means you’ll pay less interest, but keep in mind that annual fees and other charges aren’t included in a credit card’s APR. Be sure to read the fine print so you can determine whether the fees might offset the card’s benefits.
The opposite is true with APY: the higher the rate, the more interest you’ll earn on your savings. When comparing savings accounts, pay close attention to how often interest is compounded to get a better idea of how much your money is earning.
*Information about Apple Card was collected independently by Bankrate.com. Card details have not been verified or endorsed by the card issuer.
