What is the difference between APY and Interest Rate?
So, you’re diving into saving and wondering what the heck is the difference between APY and interest rate?
Let’s take a step back.
What is APY?
APY stands for annual percentage yield. APY is the total amount of interest earned on money in an account over the course of 1 year.
What is Interest Rate?
Interest is the amount of money earned by lending money out. In the perspective of a savings account, the money you deposit into a savings account to a bank, the bank is essentially lending that money from you. In return, they’ll pay you a small percentage, which they refer to as the interest rate.
Both APY and interest rate, in theory, are very similar. However, APY includes the interest earned and compounds; whereas, an interest rate only takes the original principal amount into account when calculating how much interest should be paid out at the end of the term. The term can vary from bank to bank and account to account. Typically, if the money is in a savings account, that interest may be paid out monthly.
This post is about the difference between APY and Interest Rate.
Let’s dive into the top 3 examples of the difference between APY and Interest Rate.
Example 1
Let’s say you have $1,000 to put into a savings account and you’re wondering if Bank A or Bank B have better offers. Bank A is offering an interest rate of 5%, paid after one year, no compounding available. Bank B is offering an APY of 5%, paid monthly, including compounding. Which bank is providing the better offer?
Example 2
Now, you have $10,000 and Bank A is offering an interest rate of 6%, paid after one year, no compounding available. Bank B is offering an APY of 5.5%, paid monthly, including compounding. Which bank is providing the better offer?
Example 3
Lastly, you have $5,000, and Bank A is offering an interest rate of 4%, paid after one year, no compounding available. Bank B is offering an APY or 3.5%, paid monthly, including compounding. Which bank is providing the better offer?
To reiterate, the top 3 examples of the difference between APY and Interest Rate are:
- $1,000 into a savings account. Bank A’s offer is 5% interest rate, Bank B is 5% APY.
- $10,000 into a savings account. Bank A’s offer is 6% interest rate, Bank B is 5.5% APY.
- $5,000 into a savings account. Bank A’s offer is 4%, Bank B is 3.5% APY.
There you have it! Interested in learning more about saving? Check this post out for the best HYSA (best high yield savings accounts).
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