APR vs APY: What's the Difference?

It’s natural to be confused about the difference between APR and APY, not to mention how credit card interest is calculated. But understanding the specifics of how interest is charged (or earned) is essential if you want to stay in control of your finances.

How much you’ll pay in credit card interest depends on how you use your credit card and how interest is charged to your account. And what you’ll earn in savings interest depends on how you use or move your money.

How Is APR Different from APY?

In a nutshell, APR is what you pay and APY is what you earn.

• APR is the cost of borrowing, like on a credit card or loan.
• APY is the rate of return, like through investments and deposits.

So basically APR is an outgoing amount while APY is incoming. And they apply to different types of financial products, but both are expressed as a yearly percentage. Let’s break it down into more detail.

What’s an APR?

The annual percentage rate (APR) refers to the actual percentage you pay annually on the balance of a credit card or loan. It includes the interest rate and any fees or other costs associated with securing the loan. However, it doesn’t account for compounding interest.

The APR is often called the interest rate, but the interest rate is really just one part of the APR calculation. However, for credit cards specifically, the APR and the interest rate are usually synonymous because there aren’t additional loan fees. Credit card late fees and annual fees aren’t included in the APR.

What’s an APY?

The annual percentage yield (APY) is the total percentage you can earn on a savings account, certificate of deposit (CD), or investment. It includes the effect of compounding interest as well.

While some people also use the term APY to refer to loan or credit card rates with compound interest included — and talk about the difference between APR and APY on a loan — you’ll most often see it as an earning rather than an expense. So instead of it being something you pay on your loan or credit card, it’s the amount you can earn on a deposit or investment.

The Truth in Savings Act puts some requirements in place for financial institutions offering interest-bearing accounts and investments. They’re required to disclose the APY to two decimal points, spell out “annual percentage yield” at least once, and can’t say “interest rate” without also stating the APY. Again, some people use APY and interest rate interchangeably, but the APY includes the effects of compound interest on the interest rate.

How Is Credit Card Interest Calculated?

Even though banks have to disclose the APR as an annual rate, credit card interest is usually calculated using the monthly periodic rate (MPR). To find your MPR, just divide your APR by 12. For example, if your APR is 24.00%, then your monthly periodic rate is 2.00%.

Many credit card issuers use the average daily balance to calculate interest because your credit card balance may fluctuate from day to day. For example, you might have a $50 balance for the first 30 days of your billing cycle, but then make a $500 purchase on the 31^st day, so your balance is $550 at the end of the cycle. You’ll pay interest in this billing cycle on the $66.13 average daily balance of the entire billing cycle.

In the case of the 24.00% APR with a 2.00% MPR, your interest on the $66.13 average daily balance is $1.32. But let’s say you have a balance of $800 for the first 30 days, and make a purchase of $1,000 on the 31^st day.

Now with the 24.00% APR and 2.00% MPR, your interest on the $806.45 average daily balance is $16.13.

If you hold a balance on your credit card and pay less than the interest charged, your principal balance will grow by the amount of unpaid interest. Then your next payment reflects the higher accrued balance, and interest is calculated on that. In this case, if you paid $10, your next month’s interest would be calculated on the remaining $6.13 of interest as well as the $1,800 that’s still on your card.

So always paying the minimum due lets you build a positive credit history, but you might not pay down the balance very quickly.

Different APRs You Should Know About

Both APRs and APYs can be fixed-rate or variable-rate. Fixed APRs and APYs remain the same for the entire term or stated period of time, while variable APRs and APYs change with economic conditions. For example, if the federal funds rate changes, so will a variable APR or APY.

There are also different APRs that you could be charged on a single credit card. There’s an APR for purchases, an APR for balance transfers, and an APR for cash advances. These rates may or may not be the same, but your credit card agreement will spell out the details.

Bottom Line

When you understand how your interest is applied to your account, you can see where small changes help pay down your balance faster and reduce the amount you’ll pay in interest. By making an additional payment in the middle of your cycle and paying more than your minimum payment, you can drive down that average daily balance and lower your interest charges.

Making those regular on-time payments can also help increase your credit score. And increasing your credit score generally means lower APRs the next time you borrow. So the more you know, the more informed your financial choices can be … and the more you can save overall.

If you need a credit card to start or continue your financial journey, consider one of the many options available from Credit One Bank. All of them offer points or cash back rewards. And in most cases, your cash advance APR is the same as your purchase APR, allowing you to choose how you spend your money.