APR, APY, and Interest Rate Are Three Different Numbers
They look interchangeable and are not. One includes fees, one includes compounding, and one includes neither. Confusing them is how a 6.25% mortgage ends up more expensive than a 6.75% one.
Three numbers appear constantly in financial products, and they are routinely treated as synonyms. They are not. Each answers a different question, and knowing which one you are looking at determines whether you can meaningfully compare two offers.
| Term | Includes fees? | Includes compounding? | Used for |
|---|---|---|---|
| Interest rate (nominal) | No | No | Calculating your payment |
| APR (annual percentage rate) | Yes | No | Comparing the cost of borrowing |
| APY (annual percentage yield) | N/A | Yes | Comparing what savings actually earn |
The interest rate: what your payment is built from
The nominal interest rate is the figure used to compute what you owe each period. On a mortgage, it is the number that goes into the amortization formula and produces your monthly principal and interest payment. It is the most visible rate and the least useful for comparison, because it deliberately excludes everything else the loan costs.
APR: the rate with the fees folded in
The APR expresses the total cost of borrowing, including interest plus most lender fees, origination charges, and discount points, as a single annualized percentage. In the United States, the Truth in Lending Act requires lenders to disclose it, specifically so that two offers can be compared on one number.
The reason this matters is that a lender can lower the advertised rate by charging more up front. Consider two offers on a $300,000 30-year mortgage:
| Offer A | Offer B | |
|---|---|---|
| Interest rate | 6.25% | 6.75% |
| Discount points | 2 points ($6,000) | None |
| Monthly payment | $1,847.15 | $1,945.79 |
| Monthly saving vs B | $98.64 | n/a |
| Break-even on the $6,000 | 61 months | n/a |
Offer A has the lower rate and the lower payment, and it costs $6,000 more on day one. You need to keep the loan 61 months, just over five years, before the payment saving repays the points. Sell or refinance in year three and Offer A was the more expensive choice despite the better rate. The APR captures this; the interest rate does not.
APY: the rate with compounding folded in
APY runs in the other direction. It applies to money you are earning rather than borrowing, and it accounts for compounding frequency, the fact that interest credited monthly starts earning interest itself, while interest credited annually does not.
A 5% nominal rate produces different actual yields depending on how often it compounds:
| Compounding | Effective annual yield (APY) |
|---|---|
| Annually | 5.000% |
| Semiannually | 5.062% |
| Quarterly | 5.095% |
| Monthly | 5.116% |
| Daily | 5.127% |
The practical lesson is that compounding frequency matters less than the marketing suggests. Moving from annual to daily compounding adds about an eighth of a percentage point. A bank advertising 'daily compounding!' at 4.8% is offering less than a competitor paying 5.0% compounded annually. Compare APYs and the question resolves itself, which is precisely why the Truth in Savings Act requires deposit accounts to disclose APY.
The asymmetry worth noticing
There is a structural quirk here that works against consumers who are not paying attention. Loans are advertised using APR, which includes fees and makes borrowing look appropriately expensive. Savings accounts are advertised using APY, which includes compounding and makes saving look appropriately attractive. Both conventions are honest and both are required by law.
But credit cards are quoted in APR, and they compound, usually daily. A card with a 24.99% APR that compounds daily has an effective annual cost closer to 28.4%. The APR disclosure is accurate as far as it goes; it simply does not include the compounding effect, because APR is not designed to. Anyone carrying a balance is paying meaningfully more than the quoted number suggests.
A short checklist
- Comparing two loans of the same term? Use APR. It is the number the disclosure regime built for exactly this.
- Comparing loans of different terms? APR alone is insufficient. A 15-year and 30-year loan with identical APRs have wildly different total costs. Compare total interest paid.
- Expecting to sell or refinance within a few years? Weight the up-front fees heavily and largely ignore the APR advantage from points.
- Comparing savings accounts or CDs? Use APY. It already contains the compounding frequency, so the advertised compounding schedule is noise.
- Carrying a credit card balance? Assume the true cost exceeds the stated APR, because daily compounding is not reflected in it.
Frequently asked questions
Why is the APR on my mortgage higher than the rate I was quoted?
Because the APR includes the fees the rate excludes: origination charges, discount points, mortgage insurance in some cases, and certain third-party costs. A gap of roughly 0.1 to 0.3 percentage points is typical on a conventional mortgage. A much larger gap signals substantial up-front costs and is worth itemizing on the Loan Estimate before proceeding.
Can a loan's APR ever be lower than its interest rate?
Rarely, but yes. It can happen when a loan carries lender credits that offset fees, or on certain adjustable-rate products where the APR calculation incorporates an assumed future rate below the initial one. If you see it, ask the lender to explain which specific credits or assumptions produce it, since the answer determines whether it reflects a genuine benefit.
Is APY the same as APR for a savings account?
No, and savings products are quoted in APY for good reason. If a bank quotes a 5% nominal rate compounded monthly, the APY is 5.116%, which is what you actually earn over a year. Some institutions display both; the APY is the one to compare. For borrowing products the convention is reversed, which is the main source of confusion between the two terms.
Does APR include everything I pay to get a loan?
No, and this is a common misconception. APR covers finance charges as defined by regulation, but excludes several real costs, typically appraisal fees, credit report fees, title insurance in some circumstances, and home inspection. Two loans with identical APRs can still differ by well over a thousand dollars in cash required at closing. Compare the Loan Estimate's total closing costs alongside the APR.
How do I compare a loan with points against one without?
Compute the break-even: divide the cost of the points by the monthly payment saving they buy. In the example above, $6,000 of points saving $98.64 a month breaks even at 61 months. If you expect to hold the loan well beyond that, the points are worth it; if not, they are not. Then sanity-check with the APR, which assumes you hold to term and therefore favours points more than a realistic holding period would.
Disclaimer: This article is educational and does not constitute financial, investment, tax, or legal advice. Figures are illustrative and computed from the assumptions stated in the article; your own situation will differ. Verify any decision with a qualified professional before acting on it.