Understanding the difference between interest rates and annual percentage yield (APY) can help you make more informed decisions when opening an interest-bearing account. Below are the key differences, along with examples.
Interest Rate
In the context of a deposit account, the interest rate is a percentage of your balance that your financial institution will pay you for keeping your account open. It’s a basic representation of how much money you can earn without considering the amount of times interest may be added to your principal balance throughout the year.
Example
If your high-yield account has a balance of $1,000 that earns 4% interest, your return would be $40 over one year.
Annual Percentage Yield
APY reflects the total interest you can earn on an account in one year. The higher the APY, the better. This percentage is what you will want to pay attention to before opening an interest-bearing account, as it’s a more accurate measurement of your potential earnings over time.
APY is generally determined by two factors: the interest rate and its compounding frequency. Compound interest allows you to earn additional interest on your principal balance and any interest your account has already accumulated. This means the more frequently interest is compounded, the higher your return is likely to be.
Example
If two financial institutions offer high-yield accounts with the same interest rate, the account that compounds interest monthly will produce a higher APY than one that compounds quarterly.
APY makes it easier to compare interest-bearing accounts across all financial institutions to ensure you maximize your returns.
Both interest rate and APY are great ways to measure how your money will grow. Speak with a banker for additional guidance on how your account’s interest rate and APY impact the growth of your money.
