APR vs. APY: What's the difference?

Not sure what the difference is between APR and APY? Both involve interest rates and how interest is calculated on the money you borrow and on the money you invest or save. It's important to understand what they are and how they are calculated, so you can make informed decisions when you open an account or borrow money.

Annual percentage rates (APRs) and annual percentage yields (APYs) turn the cost of borrowing into simple-to-compare percentages. APRs are for when you borrow money, and APYs are for when you deposit money and earn interest.

Below, we'll take a closer look at APR vs. APY: What they mean, how they're calculated and what can affect the rates you pay or earn.

What is APR?

An annual percentage rate (APR) can tell you how much you'll pay to borrow money on an annual basis. APRs are most commonly used when calculating interest on credit cards, loans and mortgages.

You'll often see a range of APRs rather than a single number. The APR you receive on a loan or line of credit could depend on your creditworthiness, the type of credit account, how much you're borrowing and current market conditions.

APR takes a loan's interest rate and required fees into account, but doesn't consider how often interest compounds. Lenders often charge compounding interest, or interest on the interest you've already accumulated. Interest can compound daily, weekly, monthly or annually.

How APR is calculated

A loan or credit card's APR is calculated using this formula:

((total interest + fees) / loan amount) / number of days in the loan's term) x 365 x 100.

Fortunately, you don't need to calculate APRs by hand. Online calculators are available, and most lenders have to advertise the APR for the loans and credit cards they offer.

APRs can be helpful when you're comparing loan offers from competing lenders who are charging different fees and interest rates.

Consider these two loan offers:

Loan A has a lower interest rate, but the upfront origination fee results in you repaying $500 more than you would with Loan B. The higher cost of borrowing is reflected in the loan's higher APR. That's why it's important to consider all terms related to a loan or line of credit, not just the interest rate.

What is an APY?

The annual percentage yield (APY) on an account tells you how much interest you'll earn if you deposit money into the account. It's often advertised on savings accounts, certificates of deposit (CDs) and money market accounts.

An account's APY depends on its interest rate and how often the interest compounds — if an account has any fees, they aren't part of the equation.

The APY on deposit accounts could vary depending on several factors, including the financial institution, type of account, and how much money you're depositing. But all else being equal, an account with a higher APY will pay you more interest over time.

How APY is calculated

APY is calculated using this formula:

APY = (1 + r/n)n – 1

Where r is the interest rate (converted to a decimal point) and n is the number of times interest compounds each year.

For example, if a savings account has a 3.93% interest rate and the interest compounds monthly, the account will have a 4.00% APY. You'll earn $4 of interest, not $3.93, if you keep $100 in the account for a year.

However, financial institutions have to advertise APYs, so you can compare them without doing any math. Several online calculators are available as well, where you can plug in the interest rate and compounding frequency to see your APY.

What's the difference between an APR and an APY?

APR and APY can help people understand how much they'll spend or earn when borrowing and lending money. They can both be more helpful than looking at interest rates alone because APRs include fees and APYs include compounding interest.

The main difference between APR and APY is when and how they're used. APR is used when borrowing money and can help give you a picture of how much you'll pay in interest in a year's time. Banks and financial institutions advertise APRs for credit cards, loans and mortgages.

APY is used when saving or investing money and can help provide a picture of how much money you'll earn from compounding interest over the course of a year. Banks and financial institutions advertise APY for savings accounts, CDs, money market accounts and other investment accounts.

APR vs. APY: What to look for

An APR will vary depending on the type of loan or line of credit. For example, credit card APRs are often much higher than those for a mortgage.

There is also sometimes inconsistency in which fees are included in the APRs, so it's still important to review loan offers closely. Additionally, credit cards don't include any fees in the card's APR. Consider how required and potential fees could affect how much you'll pay to use a credit card.

Similarly, APYs can vary depending on the type of account. For example, CDs often have higher APYs than savings accounts. CDs also allow you to lock in an APY. Savings accounts generally have variable APYs, which means the rate — and how much interest you'll earn — can change at any time.

Additionally, APYs don't include fees. You could look for an account that offers the highest possible APY, as that will give you the most interest earnings. But sometimes opening an account with a lower APY might make more sense if the account has fewer requirements and potential fees.

The bottom: Before opening an account or borrowing money, be sure to look at the whole picture and read the fine print. Research whether or not the interest rate is fixed or variable, if there are any fees associated with the account and any minimum balance requirements.

Start earning interest with a Citizens' savings account

If you're looking for an account that earns interest, consider a Citizens' savings account. There are several options, so you can find the one that makes the most sense given your financial situation and goals.