APR vs. APY… What’s the difference?

Anyone who has shopped rates – whether for putting money in a CD or savings account, or for borrowing with a mortgage or credit card – has noticed banks and lenders using two acronyms that are almost, but not quite, the same. Sometimes they quote APR, other times APY. What gives?

APR stands for Annual Percentage Rate, and is the basic rate a bank either pays for deposits or charges for a loan. It’s the fixed percentage applied to your balance over the course of the year.

But as many savers and borrowers know, interest grows when it compounds. And that’s where APY comes in. APY stands for Annual Percentage Yield, and it’s the rate you’ll actually yield as a result of compounding.

Mortgages typically compound monthly and credit cards daily. For bank deposits, compounding may occur this often, or may just happen quarterly or semi-annually. The more compounding periods in a year, the bigger the gap between APR and APY.

That’s because interest is charged on previous interest each period. Do it just twice a year and the compounding effect is slight. But if it’s done 12 or even 365 times in a year, compounding will inflate the APY to a noticeably higher number than the original APR.

From there it’s easy to see why mortgage and credit card lenders typically quote the lower APR, while banks soliciting your deposits tend to quote the higher APY.

How much of a difference can it make? Take a mortgage quoted at 4.5 percent APR. After compounding monthly, the rate you’ll actually pay by the end of the year, or the APY, will be 4.59 percent.

Understanding this allows you to ensure you’re comparing apples to apples – APR to APR, or APY to APY, but never mixed – whenever you shop rates.