APY vs. Interest: What’s the Difference?

What Is APY?

An account's APY takes the account's interest rate and compounding into consideration to help you understand how much interest you can earn over a year.

Example: You deposit and keep $100 in a high-yield savings account with a 4% APY. After a year, you will earn $4.

Certificates of deposit (CDs) tend to offer a fixed APY for a specific term. Comparing CDs' APYs can help you identify which account will net you the most earnings.

The APYs on savings and money market accounts can also be helpful. However, your actual earnings will depend on whether you withdraw or deposit money into the account. Changing federal interest rates can also lead banks to lower or increase the interest rate on your savings account, which will affect its APY and your earnings.

What Is Interest?

Interest is the cost of borrowing money. When you deposit money in an interest-bearing account, the financial institution pays you interest to use your money. Alternatively, you'll have to pay interest if you borrow money from a lender, like for a mortgage.

Interest can be applied as simple interest or compound interest.

• With simple interest, the interest rate only applies to the principal balance, such as the amount you borrow on a loan or deposit into a savings account.
• With compound interest, the interest rate applies to the principal balance and any outstanding interest each compounding period.

Learn more: How Does Interest Work on a Savings Account?

How Is APY Calculated?

To calculate APY, you can use an online APY calculator. Alternatively, you can apply the APY formula:

However, if you're looking at the APY on a deposit account, the financial institution has to calculate it using:

A savings account without a stated term has an assumed term of 365 days. As a result, the financial institution can use the simplified APY = 100 (interest/principal).

APY vs. Interest Rate Example

The APY and interest rate will be the same thing if an account uses simple interest. However, when the account compounds interest, the APY will be higher than the interest rate.

Consider a CD that has a 4% interest rate and a one-year term. If the interest compounds monthly, one-twelfth of the interest rate gets multiplied by the principal balance each month. The interest is added to the principal balance, leading to more interest earnings the next month.

Here's what that looks like with a $1,000 CD (skipping months four through 11):

How to Compare APYs to Choose a Savings Account

Comparing APYs can be a helpful way to determine which account might offer you the most interest over the coming year.

Banks that advertise a rate of return on a savings account have to tell you the account's APY. And because the APY takes compounding into account, you can get an apples-to-apples comparison without worrying about whether the accounts have different compounding frequencies.

However, you still want to review the fine print to see if the APY only applies if you maintain a certain balance or meet certain conditions.

Learn more: How to Choose the Best Savings Account for Your Needs

Savings calculator

Types of High-Interest Savings Accounts

Different types of accounts can have varying benefits and requirements, and the ones listed below tend to offer the highest interest rates.

• Online high-yield savings accounts: Online-only accounts may have high APYs, low minimum deposit requirements and few fees.
• Certificates of deposit: A CD might offer a higher interest rate than other savings accounts, but you agree to keep your money locked in the CD for a set period of time.
• Money market accounts: Money market accounts (MMAs) are savings accounts that also offer a debit card or checks. Some require a large minimum deposit and have tiered APYs depending on your ongoing balance.
• Cash management accounts: A cash management account (CMA) isn't technically a savings account, but it's similar to a bank account at an investment or brokerage firm. CMAs tend to offer good rates, and you might be able to write checks or use a debit card tied to the account.

Aside from CDs, the accounts usually have a variable APY, which means the rate might drop after you open the account. While opening an account is easy, moving all your finances to a new bank isn't.

To consistently get the best rate on their savings, some people open an account specifically for their emergency fund or other savings goal. Since they're not regularly using the account, it's easy to switch to a higher-rate account when they find one.

Learn more: Pros and Cons of High-Yield Savings Accounts

Frequently Asked Questions

The Bottom Line

Interest rates and APYs can be different, but you usually don't have to overthink it. Most financial institutions advertise APYs, and you can compare them to see which account might pay you the most interest. However, even though APYs consider compounding, they don't account for balance requirements, fees or other features that might make an account a good or bad fit.