Interest basics

APR is the yearly cost of borrowing, expressed as a rate that includes the interest rate plus certain fees, and it does not reflect compounding. APY is the yearly return on a deposit, expressed as a rate that includes the effect of compounding. Loans and credit cards disclose APR under Truth in Lending rules; savings accounts and CDs disclose APY under Truth in Savings rules. Use APR to compare borrowing offers and APY to compare deposit offers.

For the same type of account and the same terms, a higher APY means more interest on the same balance over a year. But APY is not the whole picture. Minimum balances, monthly fees, limits on withdrawals, early-withdrawal penalties on CDs, and whether the rate is variable can all change what you actually keep. Truth in Savings disclosures list these terms alongside the APY, so read them together.

Simple interest is calculated only on the original principal, so it grows by the same dollar amount every period. Compound interest is calculated on the principal plus any interest already added, so each period's interest is a little larger than the last. On $10,000 at 5% for 10 years, simple interest totals $5,000.00, while interest compounded once a year totals $6,288.95. The gap widens the longer the money sits.

Most fixed-rate installment loans charge simple interest on the outstanding balance. Interest accrues on the principal you still owe, and each payment covers that accrued interest first and the rest reduces principal. Because the payment always covers the interest due, unpaid interest does not normally get added to the balance, so nothing compounds. Your loan contract states the exact accrual method, and the Truth in Lending disclosure shows the APR and total finance charge.