Interest is, in some ways, a give-and-take dynamic. For savers, high interest rates are a good thing, as it means they’re getting paid more for lending out or storing their money. For spenders or borrowers, though, it’s just the opposite—higher interest rates mean they’re paying more for the privilege of borrowing.

As such, rising interest rates—which the U.S. is experiencing as of early 2023 —can have their pros and cons. But it’s also easy to get confused or tripped up by some of the terminology associated with interest rates, such as APR versus APY, and more. While APR and APY are somewhat related, they describe two different things.

And they tie into the give-and-take dynamic involved with interest rates, while also giving both savers (or lenders) and borrowers a way to measure the effect rates are having on their finances.

APR is short for annual percentage rate. APR represents or expresses the cost of borrowing money on an annual basis, or each year. When you take out a loan or otherwise borrow money, the cost of doing so is often or generally expressed as APR. For instance, your credit card statement may show you your outstanding balance and the corresponding APR.

In a general sense, the lower the APR, the better or friendlier the terms of the loan are for the borrower, as it means the borrower should ultimately pay less in interest for the duration of the loan.

One critical thing to remember about APR, however, is that it relates to an entire year—that is, you wouldn’t take your debt balance and multiply it by the full APR to get a sense of your monthly interest charges. Instead, you’d divide your APR by twelve, and multiply your balance by that number instead, because there are 12 months in a year, and the APR expresses an annual interest charge, not a monthly one.

Likewise, you could also calculate a daily APR, which would involve dividing your APR by 365.

APY, on the other hand, stands for annual percentage yield. It’s also sometimes called an effective annual rate, or EAR. APY is, in some ways, the inverse of APR, as it is a measure of how much interest your money earns, generates, or accrues within a year, if you were, for example, to put your money in a savings account or in some type of investment vehicle.

For investors, savers, or lenders, a higher APY is generally a good thing, as it means your money or capital is generating a higher rate of return, or more money, within the same period of time. As such, you may see banks advertise a “high APY” on savings accounts, certificates of deposit, or other savings and investment products.

But to sum it up: APR is a measure of interest costs, while APY is a measure of interest accrual—they’re similar, but have some key differences.

Perhaps the main difference between APR and APY is the fact that APR is mostly discussed in relation to debt and borrowing, whereas APY is attached to saving and investing, as noted.

Beyond that, though, the most important and impactful difference when discussing APR vs. APY is the fact that APY takes into account compounding, whereas APR does not.

Compounding, in short, means that an investor earns interest on the interest they’ve already earned. For instance, if you put $1 in the bank at a 10% APY, after one year, the investor would have $1.10. After two years, though, they’d have $1.21, as the interest would compound on not only the principal ($1), but the interest they’d already earned ($0.10), too.

Again: APY takes compounding into account when calculated, and APR does not.

Another key difference is the fact that APR may also take into account fees and related costs associated with borrowing money, which can help borrowers determine the true cost of a loan.

An example of where you might see APR is if you apply for and receive a credit card. Credit card issuers charge interest, naturally, and the interest is usually expressed as APR. For example, if you take a look at your credit card statement, you’re likely to find your effective APR and the type (fixed-rate, variable, etc.) on there somewhere. 

You may also see APRs associated with other types of loans. Auto loans or mortgage rates, for instance, are often discussed with associated APRs. Again, the APR mentioned is the annual percentage of the principal that’s being charged in the form of interest. So, for big-ticket items like homes or cars, it can amount to a lot.

APY, on the other hand, is likely to be advertised alongside savings accounts at banks, or certain investment products. An example: You walk into a bank to ask about opening a savings account, and the teller gives you a pamphlet laying out the bank’s current APY for savings accounts (and other products). That gives you an idea of how much you can expect to accrue in interest as a percentage of the principal amount you deposit.

Note, too, that there are some strict rules and regulations about how and when APY is advertised for certain financial products.

Here are a couple of simplified examples of how APR and APY might work in the real world:

To calculating APR, you can follow this formula:

APR=(f+ipn)∗250∗100f←Loan feesi←Total interest over the life of the loanp←Original loan amountn←Loan term APR=\left({{\frac{\frac {f+i} p}n}}\right)*250*100 \\ \small \\ f \gets \text{Loan fees} \\ i \gets \text{Total interest over the life of the loan} \\ p \gets \text{Original loan amount} \\ n \gets \text{Loan term} \\APR=(npf+i​​)∗250∗100f←Loan feesi←Total interest over the life of the loanp←Original loan amountn←Loan term

Say you have a credit card with a balance of $1,000, and an effective, fixed-rate APR of 6%. You could calculate your monthly payment with just those two variables. 

The first step would be to divide the APR by 12—again, since you’re trying to determine your monthly interest charge, and APR accounts for an entire year. Then, you would multiply the monthly APR figure and your outstanding balance to get your monthly interest charge:

In this example, you would pay $5 in interest on your $1,000 credit card balance for the month.

Calculating APY is more complicated than calculating APR, mostly because of the compounding effect that needs to be taken into consideration. At its core, though, you’re calculating yield—or, how much you’re eventually earning off of your deposit or investment.

With that in mind, here’s what the APY formula looks like:

APY=(1+rn)n−1r←Stated annual interest raten←Number of times compounded APY=\bigg(1+\dfrac{r}{n}\bigg)\huge^n\normalsize-1 \\ \small \\ r \gets \text{Stated annual interest rate} \\ n \gets \text{Number of times compounded} \\APY=(1+nr​)n−1r←Stated annual interest raten←Number of times compounded

So, let’s say you have $100 in a savings account, with an annual interest rate of 3%. You can plug those variables into the formula, and calculate APY from there:

In this example, your savings account would accrue $4 in interest, taking compounding into account.

APR and APY are not necessarily locked in a better-worse dynamic—instead, they’re more akin to two sides of the same coin. They have to do with either earning or paying out money in regard to interest. In that sense, the average person would likely be much happier to accrue interest, rather than have to pay it out.

To quickly recap, APR measures the cost of borrowing, expressed as an interest rate, while APY is an expression of the expected yield (as a percentage) on a deposit or investment. So, one isn’t better than the other—they’re merely different.