APR vs APY: the difference that quietly costs you money

APR and APY look like variants of the same idea. They are not. One is designed to let borrowers compare the cost of credit; the other is designed to let savers compare the return on deposits. Using the wrong one flatters whichever side of the transaction quotes it.

APR: the cost of borrowing

Annual percentage rate expresses the yearly cost of credit, and under US Truth in Lending rules it must include certain finance charges alongside interest. That makes it a better comparison tool than the nominal interest rate alone. In the EU, the equivalent disclosure is the APRC for consumer and mortgage credit.

APY: the return on saving

Annual percentage yield reflects what you actually earn over a year once interest is credited and starts earning interest itself. The UK equivalent is the AER. A nominal 5% compounded monthly produces an APY slightly above 5%; compounded daily, slightly higher again.

Where the mismatch bites

• Credit cards quote a purchase APR but often compound daily, so the effective cost of a carried balance exceeds the APR.
• Promotional savings rates may quote a headline APY that includes a bonus payable only for an introductory period.
• Comparing a loan's APR against a deposit's APY tells you nothing useful — they are constructed differently.

The reliable habit is to compare like with like: APR against APR when borrowing, APY or AER against the same when saving, and always for the same term.