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APY vs APR: The Basics About How Interest is Calculated

August 19, 2019

Whether you’re investing money or taking out a loan, it’s important to understand how your interest will be calculated. The two main methods are Annual Percentage Rate (APR) and Annual Percentage Yield (APY). Here’s a brief explanation of what they are, how they work, how they are used by banks and financial institutions to sell investment and loan products, and how to figure out how they can work for you.


What is APR and APY?

APR and APY are two ways to calculate interest on investing money or taking out loans or credit. APR reflects the simple interest rate over a year’s time, while APY describes the rate with the effect of compounding, or the interest on interest (more on this later). Both APR and APY may also incorporate any relevant fees, such as loan origination or other processing fees.


Typically, banks and financial institutions use APR when talking about interest for a loan or a credit card. The APR is the simple rate of interest that a borrower will be charged over a year. So, for example, if you buy a TV for $1,000 on a credit card with a 24 percent APR, you’ll be carrying a balance of $1,000, and you'll be charged $240 in interest in twelve months, or $20 per month.1


However, since APR doesn’t show the effect of compounding, credit card consumers would likely pay more, depending on the frequency of compounding2. Calculators that show the effect of compounding and can be adjusted to reflect your own possible savings scenarios are available on the web.


APR vs. APY: The Big Difference is Compounding

So let’s get into compounding, the interest paid on interest. While APR is simply the annual rate of interest that is paid on an investment, APY does take into account the frequency with which the interest is applied—the effects of intra-year compounding.3


In the example above, for a credit card, compounding would drive up your borrowing cost. But when you take out a high yield savings account or CD, compounding works in your favor.


Let’s say you invest $10,000 in a high yield saving account with an annual interest rate of 5 percent. If you consider only the APR, you’d expect to earn $500 per year in interest or, for example, a total of $1,500 over three years.


Now let’s re-examine that calculation assuming the 5 percent interest will be compounded annually over three years. The first year, the yield is the same: 5 percent of $10,000 is $500, so you’ll finish the year with $10,500 in principal and interest. But in year two, the interest rate now is applied to $10,500, so you’d earn $525 in interest. The third year, the 5 percent rate is applied to $11,025, and you’d earn $551.25 in interest. So in this example, a 5 percent interest rate with compounding earns you $1,576.25 in interest, or $76.25 more than the $1,500 calculated by considering the APR alone.4 As the table below shows, daily compounding would earn you $118.22 more than simple interest considering the APR alone.

Effect of Compounding on Growth of $10,000 Invested at 5 Percent5
Years Invested
(Simple Interest)
(Annual Compounding)
(Daily Compounding)
End of Year 1 $10,500.00 $10,500.00 $10,512.67
End of Year 2 $11,000.00 $11,025.00 $11,051.63
End of Year 3 $11,500.00 $11,576.25 $11,618.22
Table is for illustrative purposes only. See below for details. 

Considerations For How to Calculate APR and APY

When banks and financial institutions decide on what interest rate to promote, they generally use APY for investment products like high yield savings accounts, CDs, and money market funds. The reason is that APY shows a higher rate, and so looks better to you, the customer.6


So when researching a high yield savings account or CD, it’s important to be sure you’re comparing apples to apples—i.e., the APYs offered by the financial institutions you’re evaluating, not an APR versus an APY.


Also important is to confirm how often the institutions you’re considering are compounding the interest. As discussed above, money earns compound interest when the prior interest earned is added to the original principal or investment each time interest is calculated. With a savings account, for example, interest may be compounded daily, monthly or quarterly, and you earn interest on the interest that was added in each prior compounding period. The more frequently the interest is added to your balance, the faster savings can grow, so daily compounding is best.7


Multiple sites, such as, offer calculators that let you plug in APYs for multiple products and see the difference in interest that would be earned over time.8

When comparing APYs, you may notice that online banks tend to offer higher APYs, in part because they have lower overhead costs than traditional banks. Online banks also may charge fewer fees and have lower requirements for initial deposits than brick-and-mortar banks.9


It’s worth knowing that APYs vary depending on the financial product being considered. According to national averages published the week of July 15, 2019 for deposits of less than $100,000, interest-bearing checking accounts offer 0.04 percent APY, on average, while savings accounts average 0.1 percent, money market funds average 0.18 percent, and 60-month CDs average 1.15 percent.10 However, as indicated above, there also are options that offer significantly higher APYs.

The Bottom Line


APR and APY are used by banks and financial institutions to describe your interest rate, whether for  loans or investments, but they mean different things. The difference is compounding, or the ability to earn interest on interest. Banks generally use APR to describe interest rates for loans or credit cards, but since APR doesn’t highlight the effects of compounding, consumers’ actual borrowing costs may be higher than expected. On the investing side, financial institutions generally use APY to describe the interest rate. APY does take into account the frequency of compounding, which can significantly add value to the money you put aside for your high yield savings account or CD, especially over longer periods of time.

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†Accounts offered by American

Express National Bank. Member FDIC. Each depositor is insured to at least $250,000 per depositor, per insured bank, per ownership category.

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*The Annual Percentage Yield (APY) as advertised is accurate as of . Interest rate and APY are subject to change at any time without notice before and after a High Yield Savings Account is opened.


For a CD account, rates are subject to change at any time without notice before the account is funded. The rate received will either be (i) the rate reflected during your application process or (ii) the rate being offered when your CD is funded, whichever is higher. All CDs must be funded within 60 calendar days from the time we approve your application or will be subject to closure. The interest rate and Annual Percentage Yield (APY) will be disclosed in your account-opening documents, which you will receive after completing your account-opening deposit. After a CD is opened, additional deposits to the account are not permitted. Early CD withdrawals may be subject to significant penalties which could cause you to lose some of your principal. Please see the Deposit Account Agreement for additional terms and conditions and Truth-in-Savings disclosures.


**The national rate referenced is from the FDIC's published Monthly Rate Cap Information for Savings deposit products. Visit the FDIC website for details.


‡For purposes of transferring funds, business days are Monday through Friday, excluding holidays. Transfers can be initiated 24/7 via the website or phone, but any transfers initiated after 7:00 PM Eastern Time or on non-business days will begin processing on the next business day. Funds deposited into your account may be subject to holds. See the Funds Availability section of your Deposit Account Agreement for more information.


♢Calculations are estimates of expected interest earned. Actual results may vary, based on various factors such as leap years, timing of deposits, rounding, and variation in interest rates. The first recurring deposit is assumed to begin in the second period after any initial deposit.


§IRA Contributions are subject to aggregate annual limits across all IRA plans held at American Express or other institutions. IRA distributions may be taxed and subject to penalties based on IRS guidelines. Required minimum distribution, if applicable, is only relevant to this IRA plan and does not take into consideration other IRA plans held at American Express or other institutions. Please see for more information. We recommend you consult with a financial or tax advisor when making contributions to and distributions from an IRA plan account.