APR vs APY, What the Difference Means in Dollars
APR and APY sound alike but answer different questions. See how each is defined in federal rules and what the gap is worth on savings and card balances.
Two numbers show up on almost every financial product: APR and APY. They look like twins, and both are written as a yearly percentage. But they are defined by different federal rules, they are used on different kinds of products, and they treat compounding in opposite ways. Once you see how each one is built, it becomes much easier to compare a savings account to another savings account, or a credit card to another credit card, without being misled.
The short version
- APY (annual percentage yield) is what you see on savings accounts, CDs, and other deposit accounts. It includes the effect of compounding.
- APR (annual percentage rate) is what you see on credit cards and loans. For a card, it is a periodic rate multiplied by the number of periods in a year, so it does not include the effect of compounding.
That single difference explains most of the confusion.
How APY is defined
Regulation DD, the federal Truth in Savings rule, defines the annual percentage yield as a percentage rate reflecting the total amount of interest paid on an account, based on the interest rate and the frequency of compounding for a 365-day period. Appendix A of the rule gives the formula banks must use. In plain terms, APY answers one question: if you left a dollar in this account for a full year at the current rate, how much would it grow, counting interest earned on interest?
Here is what compounding frequency does to a stated 4.00% interest rate:
| Interest rate | Compounding | APY |
|---|---|---|
| 4.00% | Once a year | 4.00% |
| 4.00% | Monthly | 4.07% |
| 4.00% | Daily | 4.08% |
On a $10,000 deposit, daily compounding at 4.00% produces about $408.08 in interest over 365 days, which is why the APY is 4.08% rather than 4.00%. The difference is small at savings-account rates, but it is real money, and it is the reason the rule requires APY: it lets you compare a bank that compounds daily with one that compounds monthly on equal terms.
Appendix A also includes worked examples. One shows $61.68 of interest earned on $1,000 over a 365-day term, which works out to an APY of 6.17%. The formula is the same no matter how the bank compounds behind the scenes.
How APR is defined on a credit card
Regulation Z, the Truth in Lending rule, takes the opposite approach. For open-end credit like a credit card, section 1026.14 says that when periodic rates are used to compute the finance charge, the APR is computed by multiplying each periodic rate by the number of periods in a year.
So if a card charges a daily periodic rate of 0.06%, the APR is 0.06% times 365, or 21.9%. If a card charged 1.5% per month, the APR would be 1.5% times 12, or 18%. No compounding is built into either number.
But balances that are not paid off do compound. Interest added this month becomes part of the balance that is charged interest next month. That means the cost of carrying a balance for a full year is higher than the APR suggests:
| Stated APR | How it is built | Effective yearly cost if interest compounds and nothing is paid |
|---|---|---|
| 18% | 1.5% monthly x 12 | 19.56% |
| 21.9% | 0.06% daily x 365 | 24.47% |
The effective figures above are an illustration of what compounding does when a balance sits untouched for a year. Real statements vary with payments, new purchases, and the card's balance method.
Why the two are not interchangeable
The practical rule is simple: compare APY to APY, and APR to APR. Mixing them gives a misleading answer in both directions.
- A savings account advertising a 4.00% interest rate and a competitor advertising a 4.05% APY are close to identical once compounding is counted. The APY is the fair comparison.
- A card with a 21.9% APR costs more than 21.9% a year if the balance is carried, because unpaid interest compounds. The APR understates the full-year cost of revolving debt.
There is also a detail in Regulation Z worth knowing: an APR is considered accurate if it is within one-eighth of one percentage point of the rate determined under the rule. That tolerance matters little to a household, but it is a reminder that APR is a standardized disclosure, not a guarantee of the exact dollars you will pay.
Using this when you shop
When you are comparing deposit accounts, look for the APY on the disclosure and ignore the "interest rate" headline. The APY already folds in the compounding schedule, so the higher APY generally means more interest for the same deposit and term, assuming the rate holds.
When you are comparing credit products, the APR is the standardized number, but think of it as the starting point for the cost. If you expect to carry a balance, the true yearly cost will run above the APR. If you pay in full each month and your card has a grace period on purchases, the APR on purchases may not cost you anything at all.
Key takeaways
- APY includes compounding and is used on deposit accounts; Regulation DD requires it so savers can compare accounts fairly.
- APR on a credit card is a periodic rate times the number of periods in a year, so it leaves compounding out.
- A 4.00% rate compounded daily equals an APY of about 4.08%, or roughly $408 a year on $10,000.
- A 21.9% card APR built from a 0.06% daily rate costs about 24.47% over a year if interest compounds untouched.
- Compare APY with APY and APR with APR, and treat card APR as a floor on the cost of carrying a balance.