APR vs APY: Understanding Your True Credit Card Cost
That 18% APR actually costs you 19.56% per year due to daily compounding. Here's what credit card companies don't explain.
🎯 Key Difference
- APR (Annual Percentage Rate): Stated rate, no compounding
- APY (Annual Percentage Yield): True rate with compounding
- 18% APR = 19.56% APY with daily compounding
- Result: You pay more than the advertised rate!
What is APR?
APR (Annual Percentage Rate) is the interest rate charged on credit card balances without accounting for compounding. It's the number you see advertised.
📊 How APR Converts to Daily Rate
Credit card APR: 18%
Daily rate: 18% ÷ 365 = 0.0493% per day
This daily rate is applied to your balance every single day.
Example: $5,000 Balance
Day 1 interest: $5,000 × 0.000493 = $2.47
Day 2 balance: $5,002.47
Day 2 interest: $5,002.47 × 0.000493 = $2.47
Interest compounds on interest!
What is APY?
APY (Annual Percentage Yield) is the effective interest rate accounting for compounding. This is your true borrowing cost.
💰 APR vs APY Comparison
| Stated APR | Daily Compounding | True APY | Difference |
|---|---|---|---|
| 15.00% | 365 days | 16.18% | +1.18% |
| 18.00% | 365 days | 19.56% | +1.56% |
| 21.99% | 365 days | 24.59% | +2.60% |
| 24.99% | 365 days | 28.40% | +3.41% |
*Higher APRs = bigger difference between APR and APY
Real Example: $10,000 Balance at 18% APR
Let's see how daily compounding affects your actual interest cost over one year.
Using Simple APR (No Compounding)
Starting balance: $10,000
APR: 18%
Annual interest: $10,000 × 18%
= $1,800
This is what you might expect to pay
Actual Cost (Daily Compounding)
Starting balance: $10,000
APR: 18% (APY: 19.56%)
Annual interest: $10,000 × 19.56%
= $1,956
You pay $156 MORE than expected!
How Credit Card Interest is Calculated
📋 Step-by-Step Credit Card Interest
- Step 1: Convert APR to Daily Rate
18% APR ÷ 365 days = 0.0493% daily rate
- Step 2: Calculate Daily Interest
Balance × Daily Rate = Daily Interest Charge
- Step 3: Add to Balance
New Balance = Old Balance + Daily Interest
- Step 4: Repeat Every Day
Compound effect builds up over time
Real-World Impact: Minimum Payment Trap
Making only minimum payments on credit cards demonstrates the devastating effect of compounding interest.
⚠️ $5,000 Credit Card Balance at 18% APR
Minimum payment: 2% of balance ($100 initially)
Time to pay off: 23 years, 4 months
Total interest paid: $7,186
Total amount paid: $12,186 (more than double!)
You paid $7,186 in interest on a $5,000 purchase!
How to Minimize APR/APY Impact
✅ Pay Balance in Full Every Month
Grace period means $0 interest. This is the ONLY way to avoid APR/APY.
✅ Transfer to 0% Balance Transfer Card
12-21 months interest-free. Pay off principal without compounding.
✅ Pay More Than Minimum
$200/month instead of $100 = pay off in 2.5 years vs 23 years!
✅ Negotiate Lower APR
Call issuer, request rate reduction. Average decrease: 6 percentage points.
Common Credit Card APR Misconceptions
❌ "I have a grace period, so no interest"
Grace period only applies if you pay FULL balance. Carry any balance = immediate interest.
❌ "Minimum payment is enough"
Minimum payments keep you in debt for decades. See example above: $5K becomes $12K!
❌ "APR is my actual interest rate"
Daily compounding means you pay MORE. APY is your true cost!
APY on Savings: The Flip Side
While APY hurts you on credit cards, it helps you on savings accounts and investments. Same compounding principle, but working in your favor!
💚 High-Yield Savings Account Example
Deposit: $10,000
APR: 5.00%
APY (daily compounding): 5.127%
Interest earned in year 1: $512.70
You EARN $12.70 more thanks to compounding!
💳 Calculate Your True Credit Card Cost
See exactly how much interest you'll pay on your credit card balance and how different payment amounts affect your payoff time.