Key takeaways
- APR is the simple annual rate. APY is what you actually earn in a year once interest compounds.
- A 5% rate becomes 5.116% APY with monthly compounding and 5.127% with daily compounding.
- Compare savings accounts and CDs by APY. Compare loans by APR.
- The rate itself matters far more than compounding frequency. $10,000 over 10 years earns $5,527 at 4.4% vs. $408 at 0.4%.
Banks and lenders quote rates in two ways, and they don’t pick at random. Savings accounts advertise APY because it’s the higher number, and loans advertise APR because it’s the lower one. Here’s what each means and how to use them.
APR vs. APY in one sentence each
- APR (annual percentage rate): the yearly rate without compounding. On a loan, it also folds in certain fees. See APR vs. interest rate.
- APY (annual percentage yield): the yearly rate with compounding, meaning interest earning interest during the year. The Truth in Savings Act requires banks to disclose it.
The formula: APY = (1 + r ÷ n)ⁿ − 1, where r is the annual rate and n is how many times it compounds per year.
How compounding frequency changes the yield
Here’s a 5% stated rate on $10,000, held for one year:
| Compounding | APY | Interest earned in year 1 |
|---|---|---|
| Annually | 5.00% | $500.00 |
| Quarterly | 5.095% | $509.45 |
| Monthly | 5.116% | $511.62 |
| Daily | 5.127% | $512.67 |
More frequent compounding helps, but the gains shrink fast. Monthly to daily is worth only $1.06 a year on $10,000.
Using APY to compare offers
Since APY already accounts for compounding, it puts different accounts on equal footing:
| Offer | APY |
|---|---|
| Bank A: 4.40% compounded daily | 4.498% |
| Bank B: 4.45% compounded annually | 4.45% |
Bank A’s lower stated rate compounds daily, so its APY ends up higher. Most banks advertise APY directly, so you rarely need to do this conversion yourself. But it explains why the headline rate and the APY sometimes differ.
The rate matters more than anything else
Leave $10,000 for 10 years:
| Account | Rate | Balance after 10 years | Interest earned |
|---|---|---|---|
| Typical big-bank savings | 0.4% | $10,408 | $408 |
| High-yield savings | 4.4% | $15,527 | $5,527 |
Rates on high-yield accounts change with the market, so the 4.4% won’t hold for a decade. But the gap between an account that pays almost nothing and a competitive one is often several percentage points, and moving your emergency fund takes a few minutes.
Things APY doesn’t tell you
- Whether the rate is variable. Savings and money market rates can change any time. A CD’s APY is fixed for the term.
- Fees and minimums. A monthly maintenance fee can wipe out the interest on a small balance. Some top rates apply only up to a balance cap.
- Inflation. A 4% APY with 3% inflation grows your purchasing power by only about 1% a year. See how inflation erodes savings.
- Taxes. Interest is taxed as ordinary income in the year it’s credited, even if you don’t withdraw it.
- Safety. Check that the bank is FDIC-insured (or the credit union is NCUA-insured) and that your balance is within the coverage limits.
Where compounding works against you
The same math runs on debt. A credit card APR compounds daily, so the effective rate you pay is higher than the APR on the statement. See how credit card interest is calculated.