Question 1

What is the difference between APR and APY?

Accepted Answer

APR (Annual Percentage Rate) is the simple yearly interest rate, ignoring compounding. APY (Annual Percentage Yield) is the effective yearly rate that includes the effect of intra-year compounding. APY is always greater than or equal to APR for the same nominal rate.

Question 2

How do I convert APR to APY?

Accepted Answer

APY = (1 + APR / n) ^ n − 1, where n is the number of compounding periods per year. For monthly compounding (n=12), a 5% APR becomes (1 + 0.05/12)^12 − 1 ≈ 5.116% APY. For daily compounding (n=365) it becomes about 5.126% APY.

Question 3

Which one should I use to compare savings accounts?

Accepted Answer

Always use APY. Banks are required by US law (Truth in Savings Act) to quote APY on deposit accounts because it reflects what you will actually earn. APR is more useful for loans, where compounding is usually on the unpaid balance.

Question 4

Why does compounding frequency matter?

Accepted Answer

More frequent compounding produces a higher APY for the same APR, because interest starts earning interest sooner. A 5% APR compounded daily is worth about 0.011% more per year than the same rate compounded annually — small per year, but meaningful over a decade.