APR vs. EAR: What's the Difference and Why It Matters
When comparing loans, credit cards, or investment products, you will encounter two common rate measures: APR (Annual Percentage Rate) and EAR (Effective Annual Rate). They sound similar but can differ significantly — and not understanding the difference can cost you money.
APR — The Nominal Rate
APR is the stated annual interest rate before accounting for compounding within the year. It is the simpler number and is required by law to be disclosed on most consumer loans (Truth in Lending Act). However, APR can be misleading when compounding occurs more than once per year.
EAR — The True Annual Cost
EAR (also called APY for deposit products) accounts for intra-year compounding and represents the actual annual cost or return. EAR is always equal to or higher than APR. The more frequent the compounding, the larger the gap.
| Compounding Frequency | APR | EAR | On $10,000 Balance |
|---|---|---|---|
| Annually | 5.00% | 5.000% | $500.00 |
| Semi-annually | 5.00% | 5.063% | $506.25 |
| Quarterly | 5.00% | 5.095% | $509.45 |
| Monthly | 5.00% | 5.116% | $511.62 |
| Daily | 5.00% | 5.127% | $512.67 |
Where This Matters Most
- Credit Cards: Most cards compound daily. A 29.99% APR credit card has an EAR of approximately 34.7%. That is a much more accurate picture of what you will actually pay.
- Mortgages: In the US, mortgages typically compound monthly. The APR disclosed includes certain fees, making it slightly higher than the note rate.
- Savings Accounts & CDs: Banks advertise APY (which IS the EAR), so you can compare directly. A 5.00% APY CD earns exactly 5% after one year, regardless of compounding frequency.
- Payday Loans: Often quoted with biweekly rates. A $15 fee on a $100 two-week loan has an APR of 391% — but the EAR is even higher at approximately 3,685% due to the ultra-short compounding period.
The Conversion Formula
EAR = (1 + APR / n)n − 1 where n = number of compounding periods per year
Real-World Example: Meet Mike
Mike carries a $5,000 balance on a credit card with a "competitive" 24.99% APR. He pays $200/month. What most people do not realize: that 24.99% APR compounds monthly to an EAR of approximately 28.07%. At this rate, Mike's payoff takes 32 months and costs $1,386 in interest alone.
Now consider Mike transfers his balance to a card offering 0% APR for 18 months with a 3% fee ($150). At $278/month, he pays it off with zero additional interest — saving over $1,200 compared to the original plan. Understanding the difference between APR and EAR made him $1,200 richer.
Common Mistakes to Avoid
- Comparing APRs across different compounding frequencies. A 5.00% APR compounded monthly has an EAR of 5.12%. A 5.00% APR compounded daily has an EAR of 5.13%. Always ask: "compounded how often?"
- Ignoring that credit cards compound daily. Your 29.99% credit card APR is actually a ~34.7% effective annual rate. That is the number you should have in mind when deciding whether to carry a balance.
- Assuming APR includes all costs. Mortgage APR includes certain fees, but credit card APR does not include annual fees, late fees, or balance transfer fees. Read the fine print.