A savings account and a certificate of deposit (CD) are classified as interest-bearing accounts. Interest rate and annual percentage yield (APY) refer to these accounts interchangeably. Knowing the difference between the two is essential to determine your deposit’s return rate.
Based on the compounding frequency and an account’s interest rate, an Annual Percentage Yield (APY) measures the interest earned over a year. It is a valuable tool for making financial projections over more extended periods, particularly those that involve long-term changes. The APY calculation process and the importance of APY will be explained in this article.
What is the Annual Percentage Yield (APY)?
APY or Annual Percentage Yield is a standardized way to represent the interest rate you earn on a savings account or investment over a full year, taking into account the effect of compounding interest.
An interest rate measures the return within an interest period, and simple interest accounts pay interest on the original principal. Meanwhile, compound interest accounts pay interest not just on the principal but also on any interest already accrued. Therefore, an account with 1% interest that compounds monthly earns less than an account with 1% interest that compounds annually. This is taken into account in APY.
How Does APY Work?
Over a year, APY calculates how much interest an account has earned. Compound interest is what you make on your principal amount plus interest on your earnings plus your interest rate.
Because interest is compounded more frequently on one-year term accounts than on two-year term accounts, a savings account held for one year at a lower interest rate may have more interest earned. Consumers can compare APYs since they annualize the investment, even if they hold for different periods and the interest is compounded differently, like quarterly or monthly.
Savings, checking, CDs, and money market accounts pay APY. Each of these is a deposit-type investment account.
How To Calculate APY?
There’s a formula to calculate APY. You’ll need to know the interest rate for the account in question to use the formula. Here is a calculator that can be used to estimate how much your money might grow. It’s essential to save for something specific if you’re saving for it.
| Steps | Formula |
| 1. Substitute the period rate and the compounding period number in the formula. It is compounded monthly in this case, so the compound period is 12. | (1 + 0.05 ÷ 12)12 – 1 |
| 2. Use parentheses to solve the operation. | (1.0041666666667)12 – 1 |
| 3. Give the parentheses a power of 12 by raising the quantity in parentheses. | 1.05116 – 1 |
| 4. Calculate APY by subtracting by 1. | 5.12% |
| 5. Take APY and multiply it by the amount you deposited into the account. Based on this, you will find out how much interest you have earned overall. | $1,000 x 5.116% = $51.16 |
| 6. Subtract the original deposit from the interest earned to calculate the interest earned. Your account balance at the end of the year will be determined by this calculation. | $1,000 + $51.16 = $1,051.16 |
APY Formula
Mentioned below is the formula to calculate APY:
APY = (1 + r/n)n + 1
There are n periods over which interest compounds, while r is the interest rate you earn on a deposit account. Many people run these numbers on spreadsheets, but an APY calculator is often the easiest way. The APY is something your bank or credit union usually provides, so you will only need to calculate it occasionally.
What Is a Good APY Rate?
There are often fluctuations in APY rates, and a reasonable rate may not be a reasonable rate anymore because of macroeconomic changes. The APY on savings accounts tends to rise when the Federal Reserve raises interest rates. So when monetary policy is tight or tightening, APY rates on savings accounts are usually better. Furthermore, there are often low-cost, high-yield savings accounts with competitive yields.
How To Find the Best APY?
You should find the best APY savings account to grow your savings over time. The key to getting the highest APY is to compare different banks and bank accounts beforehand.
A Guide to Finding the Best APY on Savings Accounts
Knowing where to look when searching for the best APY savings account is essential. To open a savings account, you must choose a bank, credit union, or online bank.
Online banks generally offer higher APYs than brick-and-mortar banks because their overhead costs are lower. Additionally, credit unions tend to offer their members competitive annual percentage rates.
Compare Savings Account APYs at Online Banks by Considering the following:
- Your needs and how that account fits them
- What type of APY is offered: flat or tiered
- Expenses you’ll incur
Banks can offer a single APY on savings accounts regardless of account balance. If you have $1,000 in your account, you’ll get the same APY as someone with $100,000.
Some banks reward customers with higher balances with a higher interest rate through a tiered-earning structure. In addition, some banks offer higher interest rates on balances below certain thresholds.
Considering bank fees can also help you evaluate whether any trade-offs are being made. A steep maintenance fee could negate your interest if you earn a higher APY.
Another thing to keep in mind is introductory APYs. The bank may offer an increased promotional APY during the first year of opening your account, then reduced after that. Be sure to check whether the APY offered by a savings account is ongoing or temporary before enrolling.
A Guide to Finding the Highest APY on Checking Accounts
When earning interest on your checking account, you should do some digging. The number of high-yield checking accounts is smaller than that of high-yield savings accounts. Generally, these are available only to customers with considerable balances or willing to pay more.
Consider checking out online banks’ high-yield checking options. As a result, you will not be able to access your checking account at a branch, but you may earn the highest APY by banking online, and you may also pay fewer fees or have lower minimum balance requirements.
Besides checking account annual percentage yields, you should also consider the daily withdrawal and deposit limits, check-writing limits, mobile banking access, and ATM access when comparing checking account APYs. It might not make sense in the long run to sacrifice convenience to earn a higher APY, as it may not make sense in the short run.
Special Considerations
Compound Interest
A compound is made over a set period, usually daily or monthly. Compounding interest daily gives you more money than compounding interest monthly.
The difference is manageable unless you’re dealing with large amounts, but every little bit counts.
A high annual percentage yield (APY) should be a priority when shopping for a savings account or CD. You can expect your cash to grow faster if the rate is higher. It is also essential to check how often this rate is compounded – some accounts compound daily rather than monthly, allowing you to earn more.
How Does Compound Interest Work?
Interest compounded over time is what you call compound interest.
Put, it’s interest paid on both the principal (your deposits into the account) and the interest you earn. It is possible to build wealth over a long period by investing with compounding. Unlike compound interest, the principal deposit is the only thing that earns interest with simple interest.
Different periods can be used to compound interest. Depending on the compounding method, this could occur every day, every month, every quarter, or every year.
You can calculate the compound interest rate of your money using a compound interest calculator. Using a compound interest calculator can be complicated, so here are a few things to keep in mind:
Risk
Investment yields are usually higher for investors who take on more risk or sacrifice more. You can say the same about checking, savings, and CD APYs.
Consumers who keep money in their checking accounts want to have their money available on demand to pay for expenses. Sometimes, consumers must pull out their debit cards, buy groceries, and draw from their checking accounts at short notice. Because checking accounts don’t require any risk or sacrifice from the consumer, they often have the lowest APY.
Savings accounts are suitable for holding money you don’t need right now. Before using the money, the consumer might have to transfer the money to their checking account before using it. Normal savings accounts don’t let you write checks. Since savings accounts have higher limits, they usually have higher APYs than checking accounts.
APR vs. APY: What’s the Difference?
You owe interest on borrowed funds based on the annual percentage rate, or APR. When you borrow money, you will know exactly how much you’ll have to pay via the APR, just like with an APY.
You can calculate your interest income over time using APY, which applies to savings and CD accounts. The difference between APR and APY is how much you owe and earn.
APY vs. Interest Rate
An account’s APY is how much interest you earn on money over a year, whereas an interest rate is how much interest you might earn on a savings account or investment. A bank account’s interest rate is only one component of its APY, determining how often your interest compounds. You can measure how much money you’ll make in a year by the APY of a deposit account (like a high-yield savings account).
Dividend Rate vs. APY
Rather than paying interest to members, credit unions return earnings as dividends.
Here’s the formula for calculating dividend earnings:
A = P (1 + rt)
A = interest-bearing money after n years
P = You will be responsible for paying the principal amount (your first deposit or the first credit card bill).
r = the annual dividend rate (as a decimal)
t = the number of years (time) the amount is deposited for
In the case of a credit card, the principal amount is the first payment due. Look something like this:
$10,001 = $10,000 (1 + 0.0001*1)
Dividend earnings are calculated based on the dividend rate and compounding frequency over a year.
Find out the difference between the Annual Percentage Yield and Dividend Rate.
Frequently Asked Questions
Q. Is 3% APY high?
Some financial institutions’ annual percentage yields – APYs – now exceed 3%. This kind of interest rate was unheard of earlier this year when some online banks raised APYs from 0.5% to 0.6%.
Q. How good is 5% APY?
Yes, a 5% APY is the highest interest rate you can get on the market.
Q. How much interest does $ 100,000 earn in a year?
The most common and best high-yield savings accounts have an APY of around 4.85%.
Q. Which bank gives 7% interest on savings accounts in the USA?
Landmark Credit Union and Alpena Alcona Credit Union.
Q. What does 5.00% APY mean?
You earn 5% interest on your money if your APY is 5%.
Q. Who has the highest APY rate?
The following have the highest APY rates:
- BluPeak Credit Union
- TotalDirectBank
- Milli
- Newtek Bank
- UFB Direct
- Valley Direct
- Evergreen Bank Group
- Popular Direct
