Interest rates come with fine print, and some of the most important fine print is hidden inside the acronym itself. APR and APY sound interchangeable, and financial marketing is happy to let you think they are. They are not, and the gap between them is exactly where compounding lives.
APR: the nominal yearly rate
APR stands for annual percentage rate. It is the nominal, or stated, yearly rate: the periodic rate multiplied out to a year, before accounting for compounding. If a credit card charges 18% APR and compounds monthly, the card is really charging 1.5% each month, because 18% divided by 12 is 1.5%.
The key point is what APR leaves out. Multiplying the monthly rate by 12 pretends that interest is charged only on your original balance. In reality, each month's interest is added to the balance, and the next month's interest is charged on that larger amount.
APY: the rate with compounding included
APY stands for annual percentage yield. It answers a more honest question: after a full year of compounding, by what percentage did the balance actually grow? Because each period's interest earns interest of its own, APY is always higher than APR whenever compounding happens more than once a year.
Here is the standard example. An 18% APR compounded monthly works out to a 19.56% APY. Same card, same monthly rate, but the true annual cost is 19.56%, not 18%. That extra growth is why credit card debt climbs faster than the sticker rate suggests, and it is one more reason revolving balances are so hard to outrun. Our credit card payoff calculator uses the real month-by-month compounding, so it shows the true cost of carrying a balance.
To feel the difference compounding makes in the other direction, compare any compounding account against our simple interest calculator, which grows the balance with no compounding at all.
Why the quoted number is never an accident
Once you know the two definitions, a pattern jumps out in how financial products are advertised:
- Savings products are quoted in APY. Banks advertise savings accounts and CDs using APY because it is the larger, more flattering number for something that pays you.
- Loans are quoted in APR. Lenders advertise credit cards and loans using APR because it is the smaller, more flattering number for something that charges you.
Both quotes are legal and standardized. Regulation requires deposit accounts to disclose APY and consumer credit to disclose APR precisely so products can be compared like for like within each category. But it does mean the headline number always leans in the institution's favor. The bank never chooses the presentation that makes its product look worse.
How to compare rates correctly
The rule is simple: convert everything to the same basis before comparing. Two rules of thumb follow from it.
First, when comparing a debt to a savings rate, put both in APY terms. An 18% APR card compounding monthly is a 19.56% APY cost, so paying it down is equivalent to earning 19.56% guaranteed, which no savings account approaches.
Second, when comparing two savings products, check the compounding frequency behind the APY. Two accounts with the same APY are genuinely equivalent, which is the whole point of the measure. Two accounts quoting the same nominal rate may not be, since the one compounding more often yields slightly more. You can see this play out across terms and compounding schedules in our CD calculator.
The takeaway
APR tells you the stated rate. APY tells you what actually happens to the money after a year of compounding. Whenever a rate matters to you, on either side of the ledger, find out which one you are being shown, convert if needed, and compare like with like. The one-letter difference is small on the page and large on the statement.