APY (Annual Percentage Yield)
Why APY is not used for credit cards, how it differs from APR, and when compounding actually matters.
What is APY?
APY stands for Annual Percentage Yield. You will see it on savings accounts, CDs, and money market accounts. It tells you how much your money will actually grow in a year, including the effect of compounding interest.
For example, a savings account with a 5% APY will grow $1,000 into $1,050 after one year because the bank credits interest periodically and that interest starts earning more interest.
APY vs. APR: What is the difference?
The core difference is compounding.
- APR is a simple rate. It does not account for how often interest is applied within the year.
- APY folds in the compounding frequency. If interest compounds monthly, APY will be slightly higher than the stated APR because each month's interest earns more interest in subsequent months.
A quick example: a 24% APR compounded monthly works out to about 26.8% APY. The gap grows at higher rates.
Why credit cards use APR, not APY
Credit card issuers are required by the Truth in Lending Act (TILA) to disclose the APR, not the APY. The intent is to give consumers a standardized number to compare across cards.
In practice, your credit card does compound interest daily on any unpaid balance. So your true cost is slightly higher than the APR suggests. However, the law requires APR disclosure, and that is what you will see in every card's Schumer Box.
Why this matters for borrowers
If you carry a balance, the APR understates your true annual cost slightly because of daily compounding. The difference is meaningful at high balances. The most practical defense is to pay your balance in full each month and avoid compounding entirely. See grace period for how that works.
For savings accounts, always compare APY, not the stated interest rate, because compounding frequency varies between banks.