When you compare savings accounts, you will see two numbers: the interest rate and the APY. They sound similar, but they are not the same thing. APY, short for annual percentage yield, shows what you would earn over a year once compounding is included, which makes it the better number for comparing accounts.
Key takeaways
- The interest rate is the base rate the bank pays. It does not include the effect of compounding.
- APY includes compounding, so it shows your real yearly return on a deposit account.
- The more often interest compounds, the higher the APY for the same interest rate.
- APY applies to deposit accounts such as savings, money market accounts and CDs. APR applies to borrowing.
What is an interest rate?
The interest rate, sometimes called the nominal or stated rate, is the percentage a bank pays on your balance over a year before compounding is taken into account. On its own it does not tell you how much you will actually earn, because it ignores how often the interest is added to your balance.
What is APY?
APY stands for annual percentage yield. It is the effective annual return on your money once compounding is included. Compounding means interest is added to your balance, and from then on you earn interest on that interest as well.
The APY formula
The formula is APY = (1 + r ÷ n)n − 1, where r is the interest rate as a decimal and n is the number of times interest compounds per year.
For example, a 4.00% interest rate compounded daily works out to an APY of about 4.08%. You do not need to do this math yourself, because banks must disclose the APY on deposit accounts, but it helps to understand why the two numbers differ.
How compounding frequency changes the APY
The table below uses an example interest rate of 4.00% to show how more frequent compounding increases the APY. The rate is hypothetical and used only to illustrate the effect.
| Compounding | Times per year | APY on a 4.00% rate |
|---|---|---|
| Annually | 1 | 4.00% |
| Quarterly | 4 | 4.06% |
| Monthly | 12 | 4.07% |
| Daily | 365 | 4.08% |
Why a small difference still matters
At low rates the gap between an interest rate and its APY is tiny, but it grows with higher rates and larger balances. As an illustration, $10,000 held for one year at a 4.08% APY would earn about $408 in interest, assuming no deposits or withdrawals and no change in the rate. More importantly, comparing APY with APY makes sure you are looking at like-for-like figures.
APY vs APR
APR, or annual percentage rate, is the yearly cost of borrowing on loans and credit cards and can include certain fees. APY is what you earn on deposits. When you save, you want a high APY. When you borrow, you want a low APR. They look alike but measure opposite sides of the money.
How to use APY when comparing accounts
- Compare APY with APY, not a rate with an APY.
- Check whether the APY is promotional or applies only for a limited period.
- Look for balance tiers, since some accounts pay the top APY only at certain balances.
- Check whether earning the advertised APY requires direct deposit or other conditions.
- Remember that most savings APYs are variable and can change.
- Consider fees, which can cancel out interest on small balances.
For examples of accounts to compare, see our guide to the best high-yield savings accounts or read High-Yield Savings vs Traditional Savings.
Frequently asked questions
Is APY the same as the interest rate?
No. The interest rate is the base rate, while APY includes compounding. For the same rate, an account that compounds more often has a slightly higher APY.
Which is more important, APY or interest rate?
APY is usually the better number for comparing savings accounts because it reflects what you actually earn over a year.
Do certificates of deposit use APY?
Yes, CDs also advertise an APY. Unlike most savings accounts, a CD typically locks in its rate for a set term, so the rate does not change during that period.
Is APY the same as APR?
No. APY measures earnings on deposits and includes compounding, while APR measures the cost of borrowing.
Is the APY on my account guaranteed?
Not usually. Most savings and money market accounts have variable rates that the bank can change at any time.