APR and APY both express an annual percentage, but they are used in different contexts and can include different assumptions. Compounding is the key reason two annual-looking rates can produce different results.
Nominal rate versus effective yield
A nominal annual rate states a rate before the effect of intra-year compounding. APY includes that compounding effect, so it is closer to the actual one-year growth when the rate and schedule remain unchanged.
A quick comparison
At a nominal rate of 5% compounded monthly, the effective annual yield is slightly above 5% because interest is credited during the year. The difference grows as the compounding frequency increases, though it is not unlimited.
| Measure | What it describes | Useful comparison |
|---|---|---|
| Interest rate | The stated borrowing or earning rate | Payment or basic growth |
| APR | Annualized borrowing cost under stated rules | Loan offers |
| APY | Annual yield including compounding | Deposit products |
Compare matching products
Use APY when comparing deposit products that advertise annual yield. Use APR when evaluating borrowing costs and check whether fees are included. Always confirm the institution's disclosure and compounding terms.
A worked example
Worked example: a nominal 5% deposit rate compounded monthly credits interest throughout the year, so the effective one-year yield is slightly above 5%. The same label cannot be compared without knowing the compounding schedule.
When reviewing an account, look for whether the advertised number is APY, nominal rate, promotional rate, or a borrowing APR. The product disclosure should control the final comparison.
Before comparing annual percentages, identify whether the number is nominal, effective, fee-inclusive, or tied to a specific compounding schedule.
COMMON QUESTIONS
Frequently asked questions
Is APY always higher than APR?
Not as a universal rule because the terms and fee conventions differ. When comparing the same nominal deposit rate, compounding generally makes APY higher.
What does monthly compounding mean?
Interest is calculated and added to the balance each month under the product's rules.