Understanding APR vs APY: The Difference That Costs You

Why APR and APY Are Not the Same Number

APR (Annual Percentage Rate) and APY (Annual Percentage Yield) are the two most important interest rate calculations in consumer finance, and the difference between them — compounding — costs American households billions per year in unexpected interest paid and uncollected interest earned. The fundamental distinction is that APR measures the simple annual cost of borrowing without compounding, while APY measures the effective annual yield with compounding included. The asymmetry is not accidental: when banks lend to you (credit cards, mortgages, auto loans), they quote APR to make the rate look lower; when banks borrow from you (savings accounts, CDs, money market accounts), they quote APY to make the yield look higher. Understanding the math behind this asymmetry is the difference between being a sophisticated consumer and a marketing target.

The economic stakes are substantial. According to the Consumer Financial Protection Bureau (CFPB), the average American household carries $7,300 in credit card debt at an average APR of 22.8% in 2024. Because credit card interest compounds daily on most issuer agreements, the effective APY on that debt is approximately 25.7% — meaning the household pays 2.9 percentage points more in actual interest than the APR suggests. On a $7,300 balance held for a year, that differential amounts to approximately $212 in additional interest. Multiply that across 160 million credit-card-carrying households, and the compounding asymmetry is worth tens of billions annually to the credit card industry. The same dynamic in reverse costs depositors: a savings account advertised at 4.5% APY with daily compounding has an APR of only 4.40%, and a CD advertised at 5.00% APY with monthly compounding has an APR of 4.89%.

After 14 years of reviewing loan disclosures and deposit agreements for clients, I can tell you the consumers who understand the APR-APY distinction save an average of $300 to $1,500 annually on borrowing costs and capture an additional $200 to $800 in savings yield, depending on their debt and savings positions. This guide walks through the formulas, the regulatory disclosure requirements, the real-world impact across five common financial products, and the specific strategies for using the APR-APY distinction to your advantage. Use our compound interest calculator alongside this guide to model your own scenarios.

The Formulas: How APR and APY Are Calculated

The APR formula is deceptively simple: APR equals the periodic interest rate multiplied by the number of periods in a year. For a credit card with a 22.8% APR and daily compounding, the daily periodic rate is 22.8% divided by 365, or 0.06247% per day. The APR does not account for the fact that interest assessed on day 1 itself accrues interest on day 2, day 3, and so on throughout the year — that compounding effect is captured only in the APY. The APY formula incorporates compounding using the formula APY = (1 + r/n)^n − 1, where r is the annual interest rate (APR as a decimal) and n is the number of compounding periods per year.

The two formulas in code form, with a worked example for a 22.8% APR credit card compounding daily:

APR Formula:
APR = periodic rate × number of periods per year
For 22.8% APR with daily compounding:
Daily periodic rate = 0.228 / 365 = 0.0006247
APR = 0.0006247 × 365 = 0.228 (22.80%)

APY Formula:
APY = (1 + r/n)^n − 1
Where r = APR as decimal (0.228), n = periods per year (365 for daily)
APY = (1 + 0.228/365)^365 − 1
APY = (1.0006247)^365 − 1
APY = 1.2566 − 1 = 0.2566 (25.66%)

The 2.86 percentage point gap between the APR (22.80%) and the APY (25.66%) on the same credit card is the cost of daily compounding, and it is real money out of your pocket. The gap widens as the APR rises and as the compounding frequency increases, which is why credit card issuers (high APR, daily compounding) have the largest APR-APY gap of any consumer product. The gap narrows as the APR falls and as compounding frequency decreases, which is why mortgages (low APR, monthly compounding) have a small APR-APY gap typically under 0.10 percentage points.

Compounding Frequency: The Hidden Multiplier

Compounding frequency is the variable that converts a stated annual rate into either a lower or higher effective rate, and the impact is non-trivial. The same nominal 5.00% annual interest rate produces six different APYs depending on whether compounding is annual, semiannual, quarterly, monthly, weekly, or daily. The table below shows the APY for each compounding frequency at a 5.00% nominal rate, the dollar yield on $10,000 over one year, and the marginal benefit versus annual compounding.

The table reveals two important patterns. First, the marginal benefit of more frequent compounding diminishes rapidly: going from annual to monthly adds $11.62 on $10,000, but going from monthly to daily adds only $1.05 more. Second, the difference between daily compounding and continuous compounding (the mathematical limit as n approaches infinity) is only $0.04 on $10,000 — meaning daily compounding captures essentially all the benefit of compounding, and any frequency finer than daily is marketing flourish. The practical takeaway: when comparing savings accounts, weekly or daily compounding is functionally equivalent; focus on the APY, not the compounding frequency, because the APY already incorporates the frequency.

The same logic applies in reverse to borrowing. A credit card with 22.8% APR compounded daily has an APY of 25.66%, while the same 22.8% APR compounded monthly has an APY of 25.36% — a 0.30 percentage point difference that costs the borrower $3 per year per $1,000 of balance. The compounding frequency on credit cards is set by the issuer in the cardholder agreement and is almost always daily, but a few issuer-specific variations exist (some store cards compound monthly). Always check the cardholder agreement's "Interest Charges" section for the compounding frequency if you carry a balance.

Real-World Examples: Five Common Financial Products

The APR-APY distinction plays out differently across financial products because the products have different compounding frequencies, fee structures, and regulatory disclosure requirements. The table below summarizes the APR, APY, compounding frequency, and effective cost or yield for five common financial products as of late 2024. The credit card example shows the largest APR-APY gap (2.86 points) because of the combination of high APR and daily compounding, while the mortgage example shows the smallest gap (0.09 points) because of the low APR and monthly compounding.

Three patterns emerge from the table. First, banks advertise APY for savings products (where the higher number looks more attractive to depositors) and APR for loan products (where the lower number looks more attractive to borrowers) — this is not a coincidence, and the CFPB explicitly allows both practices under the Truth in Savings Act and Truth in Lending Act respectively. Second, the gap is largest for high-APR daily-compounding products (credit cards) and smallest for low-APR monthly-compounding products (mortgages). Third, the direction of the gap is always toward the bank: on savings, the APY (what you earn) is higher than the APR (the nominal rate); on loans, the APY (what you pay) is higher than the APR (the advertised rate). The bank always wins the asymmetry.

Why Banks Advertise APY for Savings and APR for Loans

The asymmetric advertising practice is legal, regulated, and intentional. The Truth in Savings Act (Regulation DD) requires banks to disclose APY on deposit products (savings accounts, CDs, money market accounts) because APY reflects the actual yield the depositor will receive, including the effect of compounding. The Truth in Lending Act (Regulation Z) requires lenders to disclose APR on consumer loans (credit cards, auto loans, personal loans, mortgages) because APR reflects the cost of credit including most finance charges, but APR does not include the effect of compounding. The result is that depositors see the higher number (APY) for savings and the lower number (APR) for borrowing, which makes both products look more attractive than the underlying economics justify.

The regulatory logic is sound but creates the marketing asymmetry. Regulation DD chose APY for deposits because depositors care about the yield they will actually receive, and APY captures that yield accurately. Regulation Z chose APR for loans because borrowers care about the cost of credit including fees, and APR captures both the interest rate and most fees in a single number — but APR does not include compounding because the cost of compounding depends on the borrower's payment behavior (a borrower who pays in full each month pays no interest at all). The asymmetry is a side effect of two separately-designed regulations, not a deliberate deception, but the marketing departments of banks exploit it ruthlessly.

The practical defense is to convert all quoted rates to APY before comparison. For savings products, the advertised APY is the actual yield — no conversion needed. For loan products, convert the APR to APY using the formula APY = (1 + APR/n)^n − 1, where n is the compounding frequency (365 for credit cards, 12 for mortgages and auto loans). A 7.20% APR auto loan compounded monthly converts to (1 + 0.072/12)^12 − 1 = 7.44% APY. A 22.80% APR credit card compounded daily converts to (1 + 0.228/365)^365 − 1 = 25.66% APY. Once both products are expressed in APY, the comparison is apples-to-apples and the bank's marketing advantage disappears.

Effective Annual Rate (EAR): The Third Calculation

The Effective Annual Rate (EAR) is mathematically identical to APY but is the term used in lending contexts, particularly for credit cards and other revolving debt. The EAR formula is identical to the APY formula: EAR = (1 + r/n)^n − 1, where r is the nominal annual rate and n is the number of compounding periods. The credit card industry uses EAR rather than APY because Regulation Z (Truth in Lending) requires APR disclosure, and the EAR is the borrower's actual cost after compounding is applied. Some credit card issuers disclose the EAR in the cardholder agreement's "Interest Charges" section, but most do not, and you must calculate it yourself.

The EAR matters most when comparing two credit cards with different compounding frequencies but similar APRs. A card with 22.8% APR compounded daily has an EAR of 25.66%, while a card with 22.8% APR compounded monthly has an EAR of 25.36% — a 0.30 percentage point difference that costs $30 per year per $10,000 of average balance. The daily-compounding card is more expensive, but the difference is small enough that APR alone is usually sufficient for comparison. The EAR matters more for high-APR products (where the gap is larger) and for products where the compounding frequency differs materially between issuers (store cards, subprime cards).

The table shows that the APR-APY gap grows nonlinearly with the APR: at 5% APR, daily compounding adds 0.13 points; at 30% APR, daily compounding adds 4.97 points. This is why high-APR borrowers (credit card users, payday loan users, buy-here-pay-here auto borrowers) are most affected by the compounding asymmetry — they pay the largest premium above the advertised rate. A borrower carrying $20,000 in credit card debt at 25% APR compounded daily effectively pays 28.39% APY, which is $678 per year more than the APR suggests. The same borrower who consolidates that debt into a personal loan at 12% APR compounded monthly pays 12.68% APY, saving $3,142 per year in interest on the same $20,000 balance.

Continuous Compounding: The Mathematical Limit

Continuous compounding is the mathematical limit of compounding frequency as n approaches infinity, and it produces the maximum possible APY for a given nominal rate. The formula is APY = e^r − 1, where e is Euler's number (approximately 2.71828) and r is the nominal annual rate as a decimal. At a 5.00% nominal rate, continuous compounding produces an APY of e^0.05 − 1 = 5.127%, which is only 0.004 percentage points higher than daily compounding (5.127%) and 0.127 percentage points higher than annual compounding (5.000%). Continuous compounding has theoretical importance in finance (it is used in options pricing, bond yield calculations, and the Black-Scholes model) but has no practical consumer finance application, because no consumer financial product actually compounds continuously.

The reason continuous compounding matters for consumers is that it reveals the ceiling: no matter how frequently a bank compounds interest, the APY cannot exceed e^r − 1. At a 5% nominal rate, the ceiling is 5.127%, and the difference between daily compounding (5.127%) and continuous compounding (5.127%) is negligible. This means a bank advertising "continuous compounding" is engaging in marketing flourish rather than offering a meaningful advantage — daily compounding captures 99.97% of the benefit of continuous compounding at typical consumer rates. When comparing savings products, ignore the compounding frequency entirely and focus on the APY, which already incorporates the frequency and allows apples-to-apples comparison.

How to Compare Loans with Different Compounding

Comparing loans with different compounding frequencies requires converting all rates to APY (or EAR) before the comparison is valid. The most common comparison failure is comparing a credit card APR to a personal loan APR without adjusting for compounding frequency: a 22.8% APR credit card (daily compounding, 25.66% EAR) versus a 14.0% APR personal loan (monthly compounding, 14.93% EAR) is a 10.73 percentage point difference, not the 8.80 point difference the APRs alone suggest. The compounding adjustment is small for low-APR products but material for high-APR products.

The comparison is further complicated by fees, which are included in APR but not in the periodic interest rate. A mortgage with a 6.75% APR including $4,000 in origination fees has a higher effective cost than a mortgage with a 6.75% APR including $0 in fees, because the first mortgage's fees are amortized over the loan term while the second's are not. The APR calculation amortizes most fees over the loan term, which understates the cost of fees if you sell or refinance before the term ends. For mortgages specifically, the APR also includes discount points and mortgage insurance, which makes APR a useful comparison tool but not a complete one — always compare both the interest rate and the APR, and read the Loan Estimate's "Loan Costs" section to see the itemized fees.

The table shows the dramatic difference between debt consolidation options for a $20,000 balance. Moving from a credit card at 22.80% APR to a personal loan at 14.00% APR saves $2,146 per year in interest, even though the APR comparison alone (8.80 points) understates the savings. Moving the same balance to a HELOC at 9.00% APR saves $3,256 per year, but introduces risk: the HELOC is secured by the home, and default can result in foreclosure. The credit card is unsecured, and default results in credit damage but not loss of the home. The right consolidation choice depends on the borrower's risk tolerance, home equity, and commitment to not re-charging the credit card after consolidation.

Regulation DD and Regulation Z: What Lenders Must Disclose

Regulation DD (Truth in Savings Act, 12 CFR 1030) governs how depository institutions must disclose interest rates and fees on deposit accounts, and it requires the disclosure of APY rather than APR. The regulation specifies that the APY must be calculated using the formula APY = 100 × [(1 + Interest/Principal)^(365/Days in term) − 1], where Interest is the interest earned, Principal is the amount deposited, and Days in term is the number of days in the period. The disclosure must appear on the account disclosure form, on the periodic statement, and in advertising when a rate is quoted.

Regulation Z (Truth in Lending Act, 12 CFR 1026) governs how creditors must disclose the cost of consumer credit, and it requires the disclosure of APR rather than APY. The APR calculation under Regulation Z is more complex than the simple APR formula, because it incorporates most loan fees (origination, points, certain closing costs) using the actuarial method over the loan term. The regulation requires APR disclosure on the Loan Estimate (mortgages), the Credit Card Agreement (credit cards), and the Retail Installment Contract (auto loans). The APR must be disclosed "more conspicuously" than other rate disclosures, meaning in larger type or more prominent placement.

The penalty structure under both regulations is significant. Regulation DD violations can result in actual damages plus statutory damages of $100 to $1,000 per violation, plus attorney fees. Regulation Z violations can result in actual damages plus statutory damages of $200 to $2,000 per violation for individual transactions, plus attorney fees, and for class actions the statutory damages can reach the lesser of $500,000 or 1% of the creditor's net worth. These penalties are the enforcement mechanism that ensures banks disclose rates accurately, and consumers who identify disclosure violations can file complaints with the CFPB or pursue private litigation.

APR vs APY on Mortgages: The Special Case

Mortgages are a special case in the APR-APY comparison because the APR on a mortgage includes fees that are amortized over the loan term, and the APR is therefore higher than the note rate (the actual interest rate used to calculate monthly payments). A 30-year fixed mortgage with a 6.75% note rate and $4,000 in origination fees and points might have an APR of 6.92%, because the fees are spread over 30 years and added to the interest cost. The APR-APY gap on a mortgage is small (typically 0.10 to 0.30 points) because mortgages compound monthly and have relatively low APRs, but the note rate-APR gap can be 0.20 to 0.50 points due to fees.

The implication for mortgage shopping is that APR is the better comparison tool than note rate, because APR incorporates fees and allows apples-to-apples comparison. A lender offering a 6.75% note rate with $4,000 in fees has an APR of 6.92%, while a lender offering a 6.875% note rate with $0 in fees has an APR of 6.875% — the second lender is actually cheaper despite the higher note rate, because the lower fees more than offset the 0.125% rate difference. Always compare APRs, not note rates, when mortgage shopping, and read the Loan Estimate's "Loan Costs" section to verify which fees are included in the APR calculation.

The APR on a mortgage understates the true cost if you sell or refinance before the loan term ends, because the fees are amortized over the full term but must be paid up front. A $4,000 origination fee amortized over 30 years adds $11/month to the effective cost, but if you sell in 7 years you have paid only $924 of the $4,000 in amortized cost — meaning the actual cost of the fee is $4,000 spread over 7 years, or $48/month, not $11/month. This is why mortgage APR comparisons are most accurate when the holding period matches the loan term; for shorter holding periods, compare the total cost over your expected ownership horizon using a mortgage calculator.

Decision Framework: When APR Matters and When APY Matters

The decision tree below guides when to focus on APR versus APY based on the financial product and your position (borrower or depositor). The framework is built around the principle that the number you should focus on is the one that reflects your actual cost or yield — APY for deposits (because it includes compounding of yield), APY or EAR for loans (because it includes compounding of cost), and APR only when the compounding frequency is identical across the products being compared.

If you are comparing savings accounts, CDs, or money market accounts, then compare APYs directly — the APY already incorporates the compounding frequency, and the bank with the highest APY pays the most interest. Ignore the nominal rate and the compounding frequency, because the APY captures both.

If you are comparing credit cards and intend to carry a balance, then convert each card's APR to EAR using the formula EAR = (1 + APR/365)^365 − 1, and compare the EARs. The card with the lowest EAR costs the least, all else equal. If you pay in full each month, the APR and EAR are irrelevant — focus on rewards, fees, and benefits.

If you are comparing mortgages, then compare APRs (not note rates) because the APR includes most fees. Read the Loan Estimate's "Loan Costs" section to verify which fees are included, and use a mortgage calculator to compare total cost over your expected ownership horizon rather than relying on APR alone if you plan to sell or refinance within 10 years.

If you are comparing auto loans with the same term and similar fees, then compare APRs directly — the compounding frequency is typically monthly across all lenders, so the APR comparison is valid. Read the Loan Estimate to confirm no prepayment penalties and to compare the total of payments over the loan term.

If you are comparing personal loans with different fee structures, then compare APRs (which include fees) rather than note rates. A 12% APR personal loan with a 6% origination fee may have a higher APR than a 13% APR personal loan with a 1% origination fee, depending on the loan term — always use the APR for comparison and verify the total of payments on the loan disclosure.

If you are consolidating debt, then convert all existing debt APRs to EARs, calculate the weighted-average EAR of your current debt, and compare that to the EAR of the consolidation loan (calculated from the consolidation loan's APR using its compounding frequency). The consolidation loan must have a meaningfully lower EAR than your current weighted-average EAR to justify the origination fees and the credit risk of new credit inquiry.

Common Myths vs Facts

Myth: "APR and APY are the same thing"

Reality: APR and APY differ by the compounding effect, and the difference can be substantial. At a 22.8% APR with daily compounding, the APY is 25.66% — a 2.86 percentage point gap that costs the average credit card holder $212 per year on a $7,300 balance. The two terms are not interchangeable, and confusing them leads to underestimating borrowing costs and overestimating savings yields.

Myth: "Banks are required to disclose the same rate for both loans and savings"

Reality: Regulation DD requires APY disclosure for deposits, while Regulation Z requires APR disclosure for loans. The asymmetric disclosure is legal and intentional, and it creates a marketing advantage for banks: depositors see the higher number (APY) for savings, and borrowers see the lower number (APR) for loans. Convert all rates to APY yourself before comparison to neutralize the asymmetry.

Myth: "Daily compounding is much better than monthly compounding"

Reality: The marginal benefit of daily versus monthly compounding is small at typical consumer rates. At 5% nominal, daily compounding yields 5.127% APY versus 5.116% for monthly — a 0.011 percentage point difference worth $1.10 per year on $10,000. At 22.8% nominal, daily compounding yields 25.66% APY versus 25.36% for monthly — a 0.30 point difference worth $30 per year on $10,000. Focus on the APY, not the compounding frequency.

Myth: "Continuous compounding offers a meaningful advantage over daily"

Reality: Continuous compounding is the mathematical limit as compounding frequency approaches infinity, and at a 5% nominal rate the difference between daily (5.127% APY) and continuous (5.127% APY) is 0.0004 percentage points — effectively zero. Banks advertising "continuous compounding" are using marketing language, not offering a measurable advantage. Daily compounding captures 99.97% of the benefit of continuous compounding at typical consumer rates.

Myth: "A 0% APR credit card means free money"

Reality: A 0% introductory APR credit card offers free borrowing only during the promotional period (typically 12 to 21 months), after which the APR jumps to the standard rate (often 22%+). If you fail to pay the balance in full before the promo expires, deferred interest may be charged retroactively to the purchase date on some cards. Read the cardholder agreement carefully for deferred interest clauses, and have a written plan to pay the balance before the promo expires.

Myth: "The interest rate is what I'll actually pay on my mortgage"

Reality: The note rate (interest rate) is used to calculate monthly payments, but the APR reflects the true cost including fees. A 6.75% note rate with $4,000 in fees has a 6.92% APR, and the APR is the better comparison tool across lenders. For shorter holding periods, use a mortgage calculator to compare total cost over your expected ownership horizon, because the APR amortizes fees over the full loan term and understates the cost if you sell early.

Myth: "APY doesn't matter for short-term savings"

Reality: APY matters less for short-term savings (under 6 months) because the dollar impact of compounding is small, but it still matters. A $50,000 emergency fund earning 4.50% APY versus 0.01% APY generates $2,250 per year versus $5 per year — a $2,245 difference that compounds over time. Always park idle cash in a high-yield savings account rather than a checking or traditional savings account.

Frequently Asked Questions

What is the difference between APR and APY?

APR (Annual Percentage Rate) is the simple annual interest rate without compounding, while APY (Annual Percentage Yield) is the effective annual rate with compounding included. APR is used for loans (Regulation Z requires it), and APY is used for deposits (Regulation DD requires it). The difference between the two is the compounding effect, which can range from 0.01 percentage points (low-APR mortgages) to 2.86 percentage points (high-APR credit cards). Always convert APR to APY (or EAR) before comparing rates across products.

How do I convert APR to APY?

Use the formula APY = (1 + APR/n)^n − 1, where APR is the annual percentage rate as a decimal and n is the number of compounding periods per year. For a 22.8% APR credit card with daily compounding, APY = (1 + 0.228/365)^365 − 1 = 25.66%. For a 6.75% APR mortgage with monthly compounding, APY = (1 + 0.0675/12)^12 − 1 = 6.96%. Use a calculator or spreadsheet for accuracy, and confirm the compounding frequency from the loan or deposit agreement.

Why do banks advertise APY for savings and APR for loans?

Banks advertise APY for savings because Regulation DD (Truth in Savings Act) requires APY disclosure, and APY is higher than the nominal rate, making the savings product look more attractive. Banks advertise APR for loans because Regulation Z (Truth in Lending Act) requires APR disclosure, and APR is lower than the effective rate (APY or EAR), making the loan look cheaper. The asymmetric disclosure is legal but creates a marketing advantage that consumers can neutralize by converting all rates to APY before comparison.

Does compounding frequency matter when comparing savings accounts?

No, compounding frequency does not matter when comparing savings accounts, because the APY already incorporates the frequency. A savings account with 4.50% APY and daily compounding pays the same yield as a savings account with 4.50% APY and monthly compounding. Focus on the APY, the minimum balance requirements, the fee structure, and the FDIC insurance, and ignore the compounding frequency entirely.

What is the difference between APR and interest rate on a mortgage?

The interest rate (note rate) is the rate used to calculate monthly principal and interest payments, while the APR includes the interest rate plus most loan fees (origination, points, mortgage insurance) amortized over the loan term. The APR is typically 0.10 to 0.50 percentage points higher than the note rate, and the APR is the better comparison tool across lenders. Always compare APRs, not note rates, when mortgage shopping.

How much does daily compounding cost me on my credit card?

Daily compounding on a credit card with 22.8% APR increases the effective rate to 25.66% EAR, a 2.86 percentage point premium. On a $7,300 average balance held for a year, that premium costs $212 in additional interest. The cost scales linearly with balance: a $20,000 balance costs $582 per year in compounding premium, a $30,000 balance costs $873 per year. Paying credit card balances in full each month eliminates the compounding cost entirely.

What is a high-yield savings account and how does APY work?

A high-yield savings account (HYSA) is a savings account offered by online banks and certain credit unions that pays a significantly higher APY than traditional bank savings accounts, typically 4.00% to 5.25% APY as of late 2024 versus the national average of 0.46% APY. The APY is the actual yield you earn including the effect of compounding (usually daily), so a $50,000 balance at 4.50% APY earns $2,250 per year. HYSAs are FDIC-insured up to $250,000 per depositor, and the APY is variable and may change as the Federal Reserve adjusts the federal funds rate.

Is a CD's APY guaranteed for the full term?

Yes, the APY on a Certificate of Deposit (CD) is guaranteed for the full term of the CD, unlike the variable APY on a high-yield savings account. A 12-month CD at 5.00% APY pays exactly 5.00% per year for 12 months regardless of what the Federal Reserve does with interest rates during that period. The trade-off is that you cannot withdraw the funds before maturity without paying an early withdrawal penalty, typically 3 to 12 months of interest depending on the CD term.

How do I compare two credit cards with different APRs?

If you pay in full each month, the APR is irrelevant — compare rewards, annual fees, and benefits instead. If you carry a balance, convert each card's APR to EAR using the formula EAR = (1 + APR/365)^365 − 1 (assuming daily compounding), and compare the EARs. The card with the lowest EAR costs the least, all else equal. Also consider balance transfer fees (typically 3% to 5%), promotional APR periods, and penalty APRs for late payments.

What is the APR on a payday loan and how does it compare to a credit card?

The APR on a payday loan typically ranges from 300% to 650% APR, compared to 22.8% average APR for credit cards. Payday loans are structured as flat fees per $100 borrowed ($15 to $30 per $100) due in 2 to 4 weeks, which translates to triple-digit APR when annualized. A $300 payday loan with a $45 fee due in 14 days has an APR of 391%, and the effective annual rate with rolling is even higher. Avoid payday loans entirely; use a credit card, personal loan, or credit union payday alternative loan (PAL) instead.

Does the APR on a personal loan include origination fees?

Yes, the APR on a personal loan includes the origination fee, which is why the APR is higher than the note rate on personal loans with origination fees. A personal loan with a 12% note rate and a 6% origination fee has an APR of approximately 14.5% over a 36-month term, because the fee is added to the cost of credit and amortized over the loan term. Always compare APRs across personal loans, not note rates, because the APR captures the total cost of borrowing.

How does the Federal Reserve affect APY on savings accounts?

The Federal Reserve's federal funds rate directly influences the APY on savings accounts and CDs, because banks set their deposit rates based on the federal funds rate plus a spread. When the Fed raises rates (as it did from 0.25% in March 2022 to 5.50% in July 2023), savings APYs typically rise within 30 to 90 days, though some large banks (Bank of America, Chase, Wells Fargo) lag significantly. When the Fed cuts rates, savings APYs typically fall within 30 to 60 days. Online banks (Ally, Marcus, Discover, Capital One 360) adjust rates more quickly than brick-and-mortar banks.

What is the difference between nominal rate, APR, and APY?

The nominal rate is the stated annual interest rate before any fees or compounding. The APR is the nominal rate plus most loan fees (for loans) or the simple annual rate (for credit cards), without compounding. The APY is the effective annual rate with compounding included. For a savings account at 5% nominal with daily compounding, the nominal rate is 5.00%, the APR (if it were disclosed) would be 5.00%, and the APY is 5.13%. For a credit card at 22.8% nominal, the APR is 22.80% and the EAR (effective rate) is 25.66%.

How do I calculate the EAR on my credit card balance?

Use the formula EAR = (1 + APR/365)^365 − 1, where APR is the annual percentage rate as a decimal and 365 is the number of compounding periods per year (daily compounding). For a card with 22.8% APR, EAR = (1 + 0.228/365)^365 − 1 = 25.66%. To calculate the annual interest cost on a balance, multiply the balance by the EAR: a $10,000 balance at 25.66% EAR costs $2,566 per year in interest if no payments reduce the balance. Confirm the compounding frequency from your cardholder agreement before calculating.