What Is the Difference Between APR and APY on a Credit Card?

 When it comes to credit cards, you might come across two terms that can be confusing at first: APR (Annual Percentage Rate) and APY (Annual Percentage Yield). While they both have to do with interest, they serve different purposes and are used in different contexts. Understanding the difference between APR and APY is essential, especially when you're managing your credit card payments and balances.

In this guide, we'll explain the difference between APR and APY, how each is used in the context of credit cards, and how they impact your finances.

What Is APR (Annual Percentage Rate)?

APR refers to the Annual Percentage Rate, which is the interest rate you’re charged for borrowing money on your credit card over the course of a year. APR is used primarily for calculating the interest charged on credit card balances that you don’t pay off in full by the due date.

APR represents the cost of borrowing and includes the interest charged on your balance, as well as any fees (such as annual fees) that are associated with using the credit card. The APR is expressed as a percentage, and it’s the rate that will be applied to any outstanding balance carried over from month to month.

There are a few types of APRs to keep in mind:

• Purchase APR: The interest rate applied to purchases made with your credit card.

• Cash Advance APR: The interest rate applied if you use your credit card to withdraw cash.

• Balance Transfer APR: The interest rate applied to balances transferred from other credit cards.

• Penalty APR: A higher interest rate that applies if you miss payments or violate other terms of your cardholder agreement.

How APR Works:
Credit card interest is usually compounded on a daily or monthly basis. If you don’t pay your balance in full by the due date, the credit card company will apply the APR to the balance you carry over. For example, if your credit card has an APR of 18%, and you have a $1,000 balance that you don’t pay off, you would owe interest on that balance.

What Is APY (Annual Percentage Yield)?

APY, on the other hand, stands for Annual Percentage Yield. While APR represents the interest rate charged to you, APY is used to show the amount of interest you earn on an account or investment over a year, including compounding.

In the context of a credit card, APY is typically less relevant than APR, because most credit cards are designed to charge you interest rather than pay you interest. However, some credit cards may offer rewards programs or interest-bearing features, such as savings or cashback accounts, where APY might come into play.

How APY Works:
APY takes into account the compounding effect, which means the interest earned is applied to both your principal and the previously earned interest. This means that the actual amount of interest you earn in a year could be higher than the nominal interest rate due to the effects of compounding.

For example, if you had a credit card that paid interest on a deposit or balance and the card had an APY of 5%, the amount of interest earned on your balance would increase over time because the interest is calculated on both the initial deposit and the interest that accumulates.

Key Differences Between APR and APY

1. Purpose:

   • APR is used to calculate the interest charged to you on any borrowed balance on your credit card. It's the cost of borrowing money on the card.

   • APY is used to calculate the interest earned on deposits or investments, taking into account the effects of compounding.

2. Usage:

   • APR is applied to outstanding balances that are not paid off in full by the due date (like credit card purchases, balance transfers, or cash advances).

   • APY is usually applied to interest-bearing accounts where you earn interest, such as savings accounts or certain rewards programs.

3. Compounding:

   • APR typically does not consider compounding when it comes to how interest is charged on credit card balances. Credit card interest is often calculated on a daily or monthly basis but doesn’t factor in the compounding effect as strongly as APY does.

   • APY is specifically designed to take into account compounding, showing you the true amount of interest you’ll earn over the year.

4. Impact on Credit Cardholders:

   • APR affects credit cardholders directly because it determines the interest charged on balances carried over from month to month.

   • APY generally doesn't impact credit cardholders directly unless the credit card offers interest-bearing features like rewards or cashback that earn interest.

Example of APR vs. APY

Let’s break it down with an example:

APR Example:
You have a credit card with an APR of 18%. If you carry a $1,000 balance for a year without paying it off in full, you will pay interest on that balance. The interest is calculated based on the APR, and you’ll pay $180 in interest over the course of the year (assuming no other fees).

APY Example:
You deposit $1,000 into a savings account that earns 5% APY. Over a year, your balance will grow not just by 5% of $1,000, but by 5% of your balance each time interest is added to it. The result is more than $50 in interest because the interest compounds over time.

When You Might Encounter APY on a Credit Card

While APR is the dominant term when dealing with credit cards, you may encounter APY in certain situations, such as:

1. Credit Cards with Cashback Rewards: If your card offers cashback rewards that accumulate in an interest-bearing account, the interest on that account might be expressed in terms of APY.

2. Credit Cards with Savings Accounts: Some cards offer linked savings accounts where you earn interest on your deposited funds. In this case, the bank or issuer may advertise the interest in terms of APY.

3. Rewards Programs: If your card has a rewards program where points or cashback are accumulated and stored in a linked account that earns interest, the interest would be quoted as APY.

Conclusion

To sum it up, APR and APY are two different ways of calculating interest, but they serve opposite purposes. APR is the interest charged on borrowed balances, making it crucial to understand when you’re using your credit card and carrying a balance. APY, on the other hand, is used to express the interest you earn on your account, typically in savings or rewards contexts.

For most credit cardholders, APR is more important to monitor, as it directly impacts how much you’ll owe if you carry a balance. APY, however, may come into play if you have a credit card that offers interest-bearing features like cashback rewards or linked savings accounts.