What Is APY and How Is It Calculated?

APY or annual percentage yield is the total amount of interest you can expect to earn on your deposits over a 12-month period, with compounding interest.

You’ve likely come across the term APY when shopping for savings accounts. And depending on the type of account, you may have noticed that APYs can be fixed or variable. For instance, many certificate of deposit (CD) accounts offer a fixed rate while traditional savings accounts usually have a variable rate.

The APY rate can also vary across banks and different types of savings products – some offering a higher APY than others. Generally speaking, the higher the APY, the more you could earn on your money.

Let’s take a closer look at how APY works.

APY vs. interest rates: What’s the difference?

Some people often use the terms “APY” and “interest rate” interchangeably. While both are expressed as a percentage, there is an important distinction.

The interest rate doesn’t take into account the effect of compound interest. That’s where APY comes in: The APY reflects the effect of compound interest, which, in simplest terms, is the interest you earn on top of the interest you’ve accrued from your original deposit.

This is why two savings accounts could have the same interest rate but end up with different APYs if the interest on one account compounds more often than the other.

In short, APY is an important number to pay attention to when comparing savings products. It could help ensure you’re getting a competitive rate.

Good to know: Not every bank or account compounds interest at the same frequency. Interest can compound daily, monthly, or annually as determined by your bank. The key thing to remember is that the more often it compounds, the faster your money could grow. You can read more about compound interest in our article here.

How to calculate APY

An easy way to calculate APY is with an online APY calculator. But for those who are curious, here’s the formula:

So for example, if a savings account pays an interest rate of 2.23% and your account compounds interest daily, using the formula where r = 2.23% and n = 365:

APY = (1+.0223/365)^365 – 1 = 2.25%

What’s the difference between APY and APR?

Don’t confuse APY with APR. While both are related to interest rates, they’re not the same thing.

• APR comes into play when you borrow money – it reflects the interest, costs, and fees you’re expected to pay on a loan over the course of a year.
• APY applies when you put money into a deposit account, and it shows the amount of interest, including compounding, you could earn in a year.

APY on savings accounts

Certain types of savings accounts will have a higher APY than others. For instance, CDs typically pay a higher rate than a traditional savings account. The trade-off for the higher rate, however, is that your cash is locked up for a predetermined period of time (i.e., the CD term), and early withdrawals can result in a penalty (unless it’s a no-penalty CD).

Even for CD products, you’ll notice a variety of APYs offered across different terms.

Read more: Guide to CDs and Guide to Savings Accounts