When dealing with interest-bearing bank accounts, it’s important to understand the difference between annual percentage yield (APY) and interest rate. The two are similar, but they’re not exactly the same. Knowing the distinction between the two terms will help you know how much return to expect on your deposits and investments.
Here’s what you need to know about APY vs. interest rate.
APY vs. interest rate: What’s the difference?
APY reflects the total amount of interest you earn on money in an account over one year, while an interest rate is the rate at which interest is earned on the original amount. Both are expressed as percentages.
The key difference between APY and interest rate is compound interest. APY includes interest that’s earned on the original balance as well as the amount of compound interest earned in one year. Interest rate only accounts for interest earned on the original amount.
Barclays Online Savings Account
EverBank Performance℠ Savings
Which one is important to know for savings accounts?
While financial institutions are required to show rates as APY, they can also show the corresponding interest rate. When it comes to your savings account, it’s more important to know the APY, because knowing the rate that includes compound frequency (that is, how often interest is paid) will give you more precise information about how much interest you will earn within the year.
Example of the difference between APY and interest rate
Here’s an example showing how APY is different from interest rate:
Suppose you have $10,000 and earn an interest rate of 4.17% at a bank, paid after one year, without compounding. The amount of interest you earn is $417 ($10,000 x 4.17% = $417).
Now, instead of waiting one year, suppose the bank deposits a proportional share of the interest earned after one month (that is, 1/12th of the 4.17% APY). This means the total bank balance will be a little more than $10,000: $10,034.75.
After the next month, the bank deposits another proportional share of interest. When that happens, the interest earned the previous month compounds, meaning that it also earns interest. So in the second month, you’re earning interest on $10,034.75. At the end of the second month, you’ll earn $34.87 in interest and the total bank balance will be $10,069.62.
If the interest continues to compound each month at the same rate, then at the end of one year, the account would actually earn about $425. This means that with compounding, the APY would be around 4.25% ($10,000 x 4.25% = $425). You can use a savings calculator to calculate balance amounts and try other scenarios with daily, monthly and annual compounding.
So in this example, where interest is compounded monthly, the interest rate is 4.17% and APY is 4.25%.
APY to interest rate calculator
Use this calculator to convert an APY to an interest rate and see how the rates differ.
Frequently asked questions
What’s the difference between APY and interest rate?
The difference between APY and interest rate is that APY includes compound interest, and interest rate doesn’t.
Why is APY higher than the interest rate?
APY is higher than the corresponding interest rate because APY includes interest on the original amount and compound interest. In contrast, the interest rate only features interest on the original amount, with no compounding interest.
FAQs
Both are expressed as percentages. The key difference between APY and interest rate is compound interest. APY includes interest that's earned on the original balance as well as the amount of compound interest earned in one year. Interest rate only accounts for interest earned on the original amount.
Are APY and interest rate the same thing? ›
APY represents the amount of money you will earn on your deposits over the course of a year, taking into account compound interest. Interest rate, on the other hand, is the percentage at which your money will accrue interest, without considering compounding.
What is 5% APY on $1000? ›
For example, $1,000 put into an account with an annual interest rate of 5% would, in theory, earn $50 at the end of the year. However, if the rate is 5% with interest earned monthly, the APY would actually be 5.116%, earning you $1051.16 by the end of the first year.
What does 5.00% APY mean? ›
Imagine you put $10,000 in an account that earns 5% APY, compounded annually. In the first year, you'd earn $500 (5% of $10,000). Now, your total is $10,500.
What is the difference between interest rate and annualized yield? ›
Annual percentage yield (APY) refers to how much interest you earn on savings and takes compound interest into account. Annual percentage rate (APR) focuses on how much interest you'll pay for money you've borrowed.
Why should a person use APY instead of interest? ›
Both APY and APR are calculated based on interest rates, but they have additional factors, too. APYs give you the most accurate idea of an account's earning potential, while APRs give an idea of what you could owe. Since both are shown over a single year, they are more accurate than interest rate alone.
What is the difference between interest rate and annual percentage rate? ›
A loan's interest rate is the cost you pay to the lender for borrowing money. The Annual Percentage Rate (APR) is a measure of the interest rate plus the additional fees charged with the loan.
What is 3% APY on $10,000? ›
Interest can compound annually, quarterly, monthly, or even daily—the more often interest compounds, the faster your balance grows. For example, say you deposited $10,000 in a high-yield savings account with a 3% APY that compounds annually. At the end of a year, you'd have $10,300.00 in your account.
How much is $1000 worth at the end of 2 years if the interest rate of 6% is compounded daily? ›
Hence, if a two-year savings account containing $1,000 pays a 6% interest rate compounded daily, it will grow to $1,127.49 at the end of two years.
How much does a $10,000 CD make in a year? ›
The national average APY for a one-year CD is 1.74 percent, based on Bankrate research, which shows this average has increased or remained the same since March 2022. If you deposited $10,000 into a one-year CD that pays this national average rate of 1.74 percent, in one year it would be worth a total of around $10,174.
Is APY monthly or yearly? APY is the percentage rate of return on your money over one year, and it includes compound interest. The interest may be compounded daily, monthly, or yearly, depending on the deposit account.
What is APY for dummies? ›
Annual percentage yield, or APY, is a percentage that reflects the amount of money, or interest, you earn on money in a bank account over one year. APY includes compound interest. You can use a compound interest calculator to quickly see what you'll earn with a given APY.
Why is the APY and interest rate different? ›
Both are expressed as percentages. The key difference between APY and interest rate is compound interest. APY includes interest that's earned on the original balance as well as the amount of compound interest earned in one year. Interest rate only accounts for interest earned on the original amount.
What is the difference between interest rate and annual return? ›
This rate is expressed as a percentage and is based on the capital and the annual return, which is the amount earned over the course of a year. An interest rate, on the other hand, is based on additional amounts paid on a loan that are not part of the actual loan repayment itself.
What is the difference between APR and APY? ›
APR represents the amount of interest and fees you might be charged when you borrow money. The lower the APR, the less you may have to pay in interest when you borrow. APY represents the amount of interest you might earn when you save or invest money. The higher the APY, the more you may earn in interest.
How do you calculate APY from interest rate? ›
FAQs. How do I calculate my APY? If you're looking to understand the math behind calculating your APY, there's a formula: APY = 100 [(1 + Interest/Principal)(365/Days in term) - 1].
What is a good APY rate? ›
Summary: Our Top High-Yield Savings Accounts at a Glance
| High-Yield Savings Account | APY* | See More |
|---|
| Highest APY UFB Direct Secure Savings See Rates | 5.25% | See Rates |
| Upgrade Premier Savings See Rates | 5.21% | See Rates |
| EverBank Performance Savings See Rates | 5.15% | See Rates |
| Bask Bank Interest Savings Account See Rates | 5.10% | See Rates |
5 more rowsThe national average savings rate is 0.45% APY, but you can find rates higher than that. Some of the best savings rates come from online banks and are around 4.00% or higher.
Do you make more money with APY or APR? ›
In other words, APY refers to the amount of money a bank or credit union pays you, while APR refers to the amount you pay your bank. Typically, the higher the APY, the better — because you can earn more money. But the lower the APR, the better because you'll be paying less money in interest charges.
