What is APY and what does it mean for your savings?
Oct. 25, 2021
4 min read
What we'll cover
What APY is and how it differs from APR
How to calculate APY
What APY means for your bottom line
Have you noticed banks quoting their "APYs" and wondered what that means? APY stands for annual percentage yield. Banks are required to prominently display this rate for their deposit accounts, like savings accounts and certificates of deposit (CDs). APY gives you the most accurate idea of what your money could earn in a year.
What is APY?
APY indicates the total amount of interest you earn on a deposit account over one year, assuming you do not add or withdraw funds for the entire year. The annual percentage yield is expressed as an annualized rate. APY includes your interest rate and the frequency of compounding interest, which is the interest you earn on your principal plus the interest on your earnings. As you can see, APY includes several factors to give you a big-picture view of your earning potential on your deposit account.
Fixed vs. variable APY
APYs can be associated with variable or fixed rate deposit accounts. With a variable rate account, the APY can change at any time. Variable rate accounts — typically savings or money market accounts (MMA) — will usually fluctuate with market rates. On the other hand, fixed rate accounts have an APY that does not change during the term of the account. For example, CD accounts usually have a fixed rate for the term of the CD.
Some banks may offer different APYs that apply to specified balance levels or balance tiers. In other words, you may earn a different APY based on how much money is in your account. For example, some banks may offer a higher APY for higher account balances.
APY vs. APR
It’s important to note that annual percentage yield (APY) is different from annual percentage rate (APR). APR tells you how much it costs to borrow money over the span of a year and applies to a variety of credit accounts, including mortgages, credit cards, home equity loans and personal loans. Learn more about the difference between APY and APR.
How to calculate APY
You can calculate the APY on any account you’re considering a few different ways if you like to figure things out for yourself.
If you want to go old school with paper and pencil (and maybe a calculator), just apply the basic formula for APY, which takes into account the interest rate and the number of compounding periods per year. APY = (1 + R/N)N – 1; with ‘R’ being the nominal interest rate, and ‘N’ being the number of compounding periods per year.
Hands down, an APY calculator is the easiest way to calculate APY. You can also use ours to calculate your potential interest earnings.
So, what does the all mean for your wallet?
APY is designed to help consumers comparison-shop for deposit accounts. Simply put, the higher the APY, the more you can earn and the faster your bank account balance may grow. The APY normalizes many factors related to the interest calculations on deposit accounts (for example, frequency of compounding) so consumers can make simple comparisons between different deposit accounts and don’t have to get caught up in the details. A compound interest calculator, like this one, can help you make comparisons based on your initial investment, monthly contributions you plan to make, the length of time you keep the account, and compound frequency.
Take a look at the difference in potential interest earned at the end of one year with a $25,000 deposit, and have a little fun imagining the different things that extra interest could buy:
Pay attention to APY for the most accurate picture of your earnings
Don’t be tempted to ignore seemingly small differences in APYs — those numbers can really add up over time. When you’re looking to bolster your bottom line, it pays to compare APYs on CDs (certificates of deposit), savings accounts and any other savings product you consider. That way you can be sure you’re getting the most accurate estimate of your potential earnings.