The short answer
The interest rate is the base price of money. APR (annual percentage rate) is the yearly cost of borrowing, including certain fees. APY (annual percentage yield) is what a savings account actually earns in a year once compounding is counted.
When you borrow, compare APRs. When you save, compare APYs. Federal law backs this up: the Truth in Lending Act and its Regulation Z govern how lenders disclose APR, and the Truth in Savings Act and its Regulation DD govern how banks and credit unions disclose APY.
| Number | What it measures | Includes fees? | Includes compounding? | Where you see it |
|---|---|---|---|---|
| Interest rate | Yearly cost of the money itself | No | No | Loans and savings |
| APR | Yearly cost of credit, including certain fees | Yes, certain fees | No, it is a nominal rate | Loans, mortgages, credit cards |
| APY | Yearly earnings on a deposit | No | Yes | Savings, CDs, money market accounts |
Interest rate: the starting point
The interest rate is the percentage charged on a loan balance or paid on a deposit, stated per year. The CFPB describes a mortgage interest rate as the cost of borrowing the principal, without fees or other charges.
On a loan, the rate sets your payment. A $20,000 loan at 7% for 60 months has a payment of $396.02, calculated from the rate alone. The rate does not tell you what you paid the lender to get the loan, and it does not show how often interest compounds.
APY: the rate plus compounding
APY shows what you earn in one year when interest is added to your balance and then earns interest itself. The more often interest compounds, the higher the APY for the same stated rate.
Regulation DD sets out the official method in its Appendix A. That version works from the actual dollars of interest earned over the account term, and for a one-year term it reduces to interest divided by principal. The formula above gives the same answer when a fixed rate compounds evenly for a full year.
Here is what a 5% stated rate produces at different compounding frequencies, along with the interest on a $10,000 deposit held for one year. Daily compounding uses 365 days.
| Compounding | Periods per year (n) | APY | Interest on $10,000 in one year |
|---|---|---|---|
| Annually | 1 | 5.00% | $500.00 |
| Semiannually | 2 | 5.06% | $506.25 |
| Quarterly | 4 | 5.09% | $509.45 |
| Monthly | 12 | 5.12% | $511.62 |
| Daily | 365 | 5.13% | $512.67 |
The jump from annual to monthly compounding is worth $11.62 a year on $10,000. Past monthly, the gains get small. Daily compounding adds only $1.05 more than monthly.
This is why APY is the cleaner number for comparing savings accounts. Two banks might both say 5%, but if one compounds monthly and the other annually, their APYs differ. Comparing APYs puts both on the same footing. It also works in reverse: an account advertising a 5.00% APY with monthly compounding is paying a stated rate of about 4.89%.
APR: the rate plus certain fees
APR folds certain upfront costs into a single yearly rate, so a loan with a low rate and high fees does not look cheaper than it is. The CFPB explains that a mortgage APR reflects the interest rate plus items such as points, broker fees and other charges paid to get the loan. That is why APR is usually higher than the interest rate.
Worked example: a $600 fee on a $20,000 loan
You borrow $20,000 at a 7% interest rate for 60 months. The lender charges a $600 origination fee, paid at closing.
Your payment is $396.02 a month, based on the full $20,000. Over 60 months you pay $3,761.44 in interest. Add the $600 fee and the total finance charge is $4,361.44.
Because of the fee, you really received only $19,400 in usable credit while making payments sized for $20,000. The APR is the rate at which 60 payments of $396.02 repay $19,400. Solving for that rate gives an APR of about 8.29%, compared with the 7% interest rate.
A second loan at 7.25% with no fee would have a lower APR than this one, even though its interest rate is higher. That is the comparison APR is built for.
APR has limits. It is a nominal rate: Regulation Z's Appendix J defines it as the rate per period multiplied by the number of periods in a year, so it does not reflect compounding the way APY does. A 7% rate charged monthly works out to about 7.23% once compounding is counted. APR also spreads fees over the full loan term. If you plan to pay off or refinance early, fees cost you more per year than the APR suggests. Regulation Z also allows a small margin of error: for a regular loan, a disclosed APR counts as accurate if it is within one-eighth of a percentage point of the exact figure.
Which number to compare
Match the number to the direction the money flows.
- Borrowing: compare APRs on loans with the same term and type. A lower APR means a lower yearly cost of credit, fees included.
- Saving: compare APYs. A higher APY means more earnings per year, compounding included.
- Checking a payment: use the interest rate. Your monthly loan payment is calculated from the rate, the balance and the term.
Keep the comparison fair. Compare a 5-year loan with another 5-year loan, and a 30-year fixed mortgage with another 30-year fixed mortgage. A longer loan can show a lower APR and still cost more in total interest because you pay for more years.
On credit cards, the number to watch is the APR. If you carry a balance and unpaid interest is added to it, the yearly cost can exceed the stated APR. A 24% APR charged at 2% a month works out to about 26.82% a year if the interest compounds monthly and you never pay it down.
A quick way to remember it
Rate is the price tag. APR is the price tag plus certain fees, for borrowers. APY is the price tag plus compounding, for savers. Lenders must disclose APR and banks must disclose APY, so both numbers appear on loan and account disclosures by law. Use them to compare offers side by side, then run the actual numbers with a calculator before you sign.