| APR | APY | |
|---|---|---|
| Stands for | Annual Percentage Rate | Annual Percentage Yield |
| Includes compounding? | No | Yes |
| Where you see it | Loans, credit cards, mortgages | Savings accounts, CDs, investments |
| Which is higher (same underlying rate)? | Lower | Higher |
| Good for | Comparing loan costs quickly | Comparing savings or investment returns accurately |
A credit card with a 24% APR does not cost you exactly 24% per year if you carry a balance. Because interest compounds monthly, the effective annual cost is higher -- that is the APY. Lenders quote APR (the lower-looking number) on loans, and savings accounts quote APY (the higher-looking number). Both are technically honest; they just emphasize different things.
The compounding gap
The difference between APR and APY grows as the compounding frequency increases. Monthly compounding (common for credit cards and mortgages) produces a modest but real gap. Daily compounding, used by some savings accounts, produces a slightly larger one.
For comparing two savings accounts, always compare APY -- that is the actual return you will earn. For comparing two loans, comparing APR is reasonable as a first pass, but APY (or the total cost of borrowing over the loan term) is the more complete picture.