APR vs. APY vs. Interest Rate: What’s the Difference?
To many people, the terms APR and APY are synonymous with interest rate, though they have very different meanings. The main difference is that APR is interest that you pay when you borrow money, while APY is interest that you earn on your savings.
There are also slight differences in the costs that each includes and how the rate is calculated. Finally, when it comes to comparing loan rates, you want a lower APR. On the other hand, a high APY for a savings account is preferable.
Key takeaways:
- APR: Includes the interest rate borrowers pay on a loan annually plus additional costs and fees, depending on the type of loan
- APY: Describes the amount of interest that an investor can earn annually
- Interest rate: The amount of money lenders charge to borrow money
What is APR?
The acronym APR stands for annual percentage rate and is used to show the costs, including interest, you’ll pay when you borrow money. It’s used on a variety of loan products including credit cards, auto loans, personal loans, student loans and mortgages.
WIth the Truth in Lending Act (TILA), it’s easy to find the APR when you’re comparing interest rates. Under TILA lenders are legally required to provide you with the APR so that you can clearly see the cost of a loan and use this information to help you comparison shop.
Credit card APR
For credit cards, “APR” and “interest rate” mean the same thing. A credit card APR does not include fees such as annual fees, balance transfer fees, late fees or foreign transaction fees. Most credit cards use a variable interest rate, which means that your rate can go up or down over time since it’s based on the federal prime rate. However, though rare, there are a few fixed-rate credit cards.
Mortgage APR
When it comes to mortgages, the APR is calculated in a slightly different way. It includes the interest rate plus additional costs such as origination fees, underwriting fees, document preparation fees and closing costs. So when it comes to your mortgage, your APR will always be higher than the interest rate.
You need to compare both the interest rate and APR when comparing mortgage offers. You may find that one lender offers a higher interest rate but lower fees, which makes the overall APR lower and a better deal than a lender with lower interest rates. The APR is the percentage that you will pay, so when all else is equal, the lower APR will save you the most money.
Personal loan APR
Typically an APR for a personal loan includes an origination fee in addition to the interest rate. These vary between lenders but can go as high as 12.00%
Auto loan APR
For auto loans, the interest rate as well as fees are included in the APR calculation. Common fees that are charged on auto loans include an origination fee and prepayment penalties. The APR that you are offered depends highly on your credit score.
What is a good APR?
When it comes to paying interest on money that you borrow, generally you should look for the smallest number. As of this writing, the average credit card interest rate in America is 24.59%. For home, car and personal loans, the APRs tend to be lower. When comparing loan offers, don’t confuse APR and interest rate. Always compare the APRs, as they give you the most accurate picture of how much you’ll pay over the life of the loan.
How to find the APR on your credit card
The best way to find the APR on your credit card is to log in to your account either on your computer or in the mobile app. Generally, you can find your APR under “account details.” If you don’t see it there, look at a recent credit card statement. The rates and fees should be listed there, often near the bottom or on one of the last pages.
You’ll notice that there are several different APRs listed:
- The purchase APR is the interest that you pay on regular purchases when you carry a balance on your card
- The cash advance APR is often a higher APR that you’ll pay when you use your card to get cash
- The balance transfer APR is another rate that you pay if you transfer a balance from one credit card to another
Some cards come with 0% APR intro offers for a set length of time. After the promotional period ends, the remaining balance is charged interest at the regular balance transfer or purchase APR.
What is APY?
The annual percentage yield (APY) refers to the amount of interest you earn on an interest-bearing bank account like a savings account or certificate of deposit (CD).
Your APY is calculated based on an interest rate but also factors in compounding interest. Albert Einstein is said to have quoted that, “compound interest is the eighth wonder of the world,” and for good reason. Compound interest is when the interest is added to the balance, and then interest accrues on the new, larger sum.
Here’s a look at $100 compounded daily for five days at 5% interest.
| Day | 5% Interest earned | Total earnings | Balance |
|---|---|---|---|
| 1 | $5 | $5.00 | $105 |
| 2 | $5.25 | $10.25 | $110.25 |
| 3 | $5.51 | $15.76 | $115.76 |
| 4 | $5.79 | $21.55 | $121.55 |
| 5 | $6.08 | $27.63 | $127.63 |
| Total | $27.63 | $27.63 | $127.63 |
It’s easy to see the snowball effect of compound interest, and the more frequently it compounds, the faster your money grows. Of course, it doesn’t always compound daily. More commonly it’s compounded on a monthly, quarterly or annual basis.
What is a good APY?
Since APY shows how much interest you will earn on your savings account or other investments, the higher the percentage, the better. Currently, you can find savings accounts that offer rates that range from 3.00% APY all the way up to 5.35% APY.
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Variable vs. fixed rates
You’ll often find that a credit card APR is followed by the word “variable.” This means that the interest rate can change over time. Variable APRs are tied to indexed interest rates like the prime rate and can go up or down as the market changes.
Fixed interest rates are set for the term of the loan. There aren’t a lot of fixed-rate credit cards but you generally find that car loans and mortgages use fixed interest rates.
Calculating APR and APY
How to calculate APR
If you don’t know the APR of a loan, and are only presented with a dollar amount of the interest plus fees, you can figure out the APR with this calculation:
Let’s say you are borrowing $5,000 for a remodeling project and the lender is charging $600 in interest. If you plug these numbers into the formula, you’ll get an APR of 12%.
To figure out how much an APR is on a mortgage, you’d use the same formula, adding in the fees along with the interest:
Tip: Consider a 0% APR credit card
How to calculate APY
Now let’s say you’ve saved up $5,000 from cash back credit cards and getting lower auto insurance rates. You’re told you can earn $150 interest by putting it into a high-yield savings account. To find out the APY, use this formula:
Filling in the numbers, our calculation looks like this:
In this case, the APY is 3%.
Frequently asked questions
No, APY and APR are not the same although they both refer to interest rates. APY stands for annual percentage yield and is used for interest earned on savings accounts and investments. APR stands for annual percentage rate and refers to interest charged on loans such as credit card balances, car loans and mortgages.
APR is the interest that you’re charged on your car loan while APY is the interest that you earn on your savings account. APR is higher because it takes the risk of lending out the money as well as the borrower’s credit score into consideration. It also includes the interest on the money that’s being used to provide the loan as well as the bank’s cost of facilitating the loan and their profit on the loan product.
You may be able to ask your issuer to lower the APR on your credit card. Your issuer may consider your credit score, credit history as well as your payment history on the account when deciding if they will lower your APR or not. Remember, that the APR on a credit card matters most if you carry a balance from month to month. If you pay it off at the end of every billing cycle, the APR doesn’t matter as much since you won’t owe any interest.