APR vs. APY: why the difference costs (or earns) you money

These two terms get used almost interchangeably in casual conversation, but they measure different things — mixing them up can make a loan look cheaper or a savings rate look better than it actually is.

APR: the cost of borrowing, without compounding

Annual Percentage Rate is a simplified yearly cost of borrowing, generally not accounting for the effect of compounding within the year. It's mainly used for loans and credit cards to give a standardized way to compare borrowing costs.

APY: what you actually earn, including compounding

Annual Percentage Yield reflects the actual return including the effect of compounding — interest earning interest within the year. This is why a savings account advertising 5% APY will pay out slightly more over a year than a flat 5% simple rate would.

Why the direction matters

For debt, a lower APR is better — it's what you're paying. For savings or investments, a higher APY is better — it's what you're earning. Confusing the two when comparing two offers can lead to comparing numbers that aren't actually measuring the same thing.

A practical example

A credit card advertising 24% APR compounded monthly actually costs slightly more than 24% over a year once compounding is factored in — closer to 26.8% in real annual cost. Advertised APR numbers on debt often understate the true annual cost for exactly this reason.