APY (Annual Percentage Yield) and APR (Annual Percentage Rate) both describe interest rates, but they measure different things. APR is the stated interest rate without accounting for compounding. APY reflects what you actually earn or pay after compounding is factored in. The difference is small at low rates and significant at high rates or frequent compounding intervals.
The Definitions
APR is the raw annual interest rate. It does not account for how often interest compounds within the year. Lenders are required to disclose APR on loans.
APY is the effective annual rate after compounding. Savings accounts and certificates of deposit advertise APY because it shows the actual amount your money will grow in a year.
The APY Formula
APY = (1 + r/n)^n - 1
Where:
- r = annual interest rate (APR) as a decimal
- n = number of compounding periods per year
Example: A savings account with a 5.00% APR compounded monthly:
APY = (1 + 0.05/12)^12 - 1
APY = (1.004167)^12 - 1
APY = 1.05116 - 1
APY = 0.05116 = 5.116%
The account advertises 5.116% APY, even though the stated rate is 5.00%. The gap is small here, but it grows with higher rates and more frequent compounding.
Why Banks Advertise APY for Savings and APR for Loans
This is not coincidental. Banks advertise the number that makes their product look more attractive.
For savings accounts, APY is higher than APR, so that is the number they show you. For loans and credit cards, APR is lower than the effective rate you actually pay (especially with daily compounding), so that is the number they are required to disclose.
When comparing savings accounts, always compare APYs. When comparing loans, be aware that the effective cost is usually somewhat higher than the stated APR.
How Compounding Frequency Affects APY
The same 5% APR compounded at different frequencies:
Annually (n=1): APY = 5.000%
Monthly (n=12): APY = 5.116%
Daily (n=365): APY = 5.127%
The difference between monthly and daily compounding is very small at typical savings rates. The difference between annual and monthly compounding is more noticeable over longer periods.
What to Look for When Comparing Savings Accounts
When comparing HYSAs or money market accounts, the APY is the right metric because it already accounts for compounding. You do not need to run any math. A 5.00% APY account will always outperform a 4.90% APY account with identical minimum balances, regardless of their respective compounding schedules.
Look beyond the headline rate:
- Is there a minimum balance requirement to earn the advertised APY?
- Is the rate a teaser that drops after an introductory period?
- Are there monthly fees that effectively reduce the yield?
The effective yield on a savings account with a monthly fee can be significantly lower than the advertised APY, particularly for smaller balances.
Calculate APY from APR
To convert any APR to APY given a compounding frequency, or to compare yields across accounts, use the APY Calculator.