Q: I’ve heard the terms APR and APY before, but what do they mean and how are they different?

A: Both APR and APY are acronyms related to interest calculations. APR stands for Annual Percentage Rate, while APY stands for Annual Percentage Yield. Sound the same? You’re not the only one to think so.

The APR is the rate of interest calculated on a loan, interest-bearing deposit account (like a savings account or CD) or investment (money market fund or bond). If the interest rate is 5.00%, that is the number that will be used in each interest calculation, and the total amount of interest earned or paid if it is only calculated annually. For example, a $1,000 CD with 5.00% APR calculated annually would earn $50 in interest for the year.

Most interest is calculated more than once per year, and compounded. That is, each time interest is paid, that amount is added to the account total. The next interest payment is calculated based on the new total: your beginning value plus the last period’s interest. This has the long term effect of raising the amount of interest paid.

APY takes frequency of payments into account and reflects the actual amount of interest paid if you hold the investment or pay on the loan for a full year. In the example, compounding interest monthly would bring the APY to 5.12%, while compounding daily brings the APY to 5.13%

As you can see, compounding frequency can make a significant difference in the amount of interest you pay if borrowing, and earn if investing. When shopping for a loan, a lower APY means you’ll pay a less over time. Investors should look for a higher APY — more compounding means greater growth over the long term.