How APY compounds interest to help your savings grow

A blackboard with APY written on it

Annual percentage yield (APY) indicates the amount of interest that will accumulate on a sum of money kept in a bank or other financial institutions over one year. It is expressed as a percentage that tells you how much your savings will grow over a given period. APYs vary depending on the financial institution and the type of banking instrument you choose to put your money in. 

For the average investor, a high APY is often the deciding factor when considering multiple investment or savings options. Banks and credit unions offer APYs on a range of accounts that include traditional savings accounts, high-yield savings accounts, money market accounts, and certificates of deposit (CDs). Additionally, some financial institutions also offer APY on their checking accounts. 

Although it may appear smart to choose the savings product with the highest advertised APY automatically, a better understanding of how interest is calculated will help you make a more informed decision. Here’s all that you need to know about APYs before putting your money into a savings or deposit account.

What is APY?

Annual percentage yield is the total interest you can earn on a given sum of money over a year. It is different from the rate of interest because it takes into account the effect of compound interest. 

APY reflects the actual rate of return on your savings and investments, depending on how frequently interest is calculated - daily, monthly, or quarterly. For instance, let’s say two accounts have the same rate of interest, but one compounds interest daily while the other compounds interest monthly. In such a situation, the effect of compounding interest will mean the account that compounds interest daily will earn a higher APY than the one that compounds interest monthly. 

The APY earned on any account is automatically added to the balance on your savings statements.

Where to find APY

The Truth in Savings Act requires institutions to disclose APY, among other details like fees and minimum balances, when advertising interest-bearing accounts. You should be able to locate an APY on any savings product advertisement and more information about the APY’s terms in the disclosure or fine print, usually at the bottom of an advertised offer.

How does APY work?

While “APY” and “interest rate” are often used interchangeably, they are not the same. An APY reflects an annualized rate of your total potential earnings. An interest rate is just part of the total APY formula. APY also considers how often your interest compounds.

Compound interest is when the sum of your savings balance plus any accumulated interest earns additional interest. The more frequently interest compounds — whether quarterly, monthly, or even daily — the more you’ll earn on your savings.

Here's how the APY formula works:

APY formula
  • r = interest rate

  • n = number of annual compounding periods (e.g., you would input 4 for quarterly, 12 for monthly, or 365 for daily)

Let's say you want to put $10,000 into a savings account offering a 1% interest rate, compounded daily.

After one year, you will have earned a total of $100.50. Note the additional $0.50 is because of the beauty of compound interest, which we’ll discuss in detail next.

The more you save and the higher your interest rate, the bigger the difference between the interest rate and APY will be.

Keep in mind that if your savings account charges fees, they won’t be considered in the APY; you will have to subtract them from your account earnings to get an accurate yield.

Tip: If you’d rather not spend your day solving math problems, plug your numbers into this compound interest calculator.

How compound interest works for you

In the example above, you earned an additional $0.50 in savings because of compound interest. Without it, you would have earned only $100.

So what is compound interest? When you are trying to grow your money, compound interest acts like a snowball rolling through a yard of wet, sticky snow. While it may seem tiny at first, the snow can accumulate faster than you expect and serve as a powerful wealth-building tool.

Your snowball gets progressively larger as your savings and interest returns accrue more interest.

As you save more money and add to the snowball, you can earn higher amounts of interest, which allows the snowball to grow. The longer your money can compound, the bigger your snowball can get.

Continuing with our earlier example, if you invest $10,000 with a 1% APY compounded daily, you would earn the following interest after each year.

Year 1 - $100.50

Year 2 - $202.01

Year 3 - $304.54

Year 4 - $408.10

Year 5 - $512.70

The higher the APY and the more frequently your interest compounds, the more your money will work for you, allowing your balance to increase faster.

Is APY different from APR?

An annual percentage rate (APR) is how much you pay to borrow money. The Truth in Lending Act requires lenders to disclose APR and other information for borrowers.

Typically, you will see an APR when borrowing money on credit cards, car loans, or your mortgage. Although APR doesn't use compound interest, it may include fees. For example, a mortgage APR may include loan origination fees, points, or closing costs.

Here's how the APR formula works:

APR formula

For example, let's say you are applying for a five-year $20,000 car loan. The loan has a 5% interest rate and $1,000 in fees and loan costs. Factoring in the fees, your APR would be 7.03%, for a total of $2,645.48 in interest due over the five years. However, if you applied for a car loan with no fees, your interest rate and APR would be the same.

Tip: You can use this APR calculator to estimate your rates for future loans.

While APY and APR aim to standardize rates, there are some key differences, including the calculations and product types in which they’re applied.

Typically, you will see APY when you invest or save, whereas APR must be disclosed when you borrow. Here’s a breakdown of the purpose of each.

Compounding interest
Includes fees
Product types
Total interest earned on an account
Invest money (savings, checking, money market)
Total interest paid on a loan or credit account
Borrow money (credit card, car loan, mortgage)

An easier way to compare savings products

Now that you have a better understanding of APY, and how it differs from interest rate and APR, you’ll be well equipped to find the best savings products for your needs.

You could spend hours searching for savings accounts with the highest APY and combing through all the fine print. Or you could have Raisin handle the heavy lifting for you.

With Raisin, you can easily compare high-yield savings products from an exclusive network of FDIC-insured partner banks. Not only that, but you may wish to save money across a variety of savings products offered by partner banks focused on serving their communities and other mission-focused goals.

The Raisin platform allows you to select multiple high-yield banking products, and then manage all of your deposits from one account.

Learn more about how to maximize your savings with Raisin here.

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*APY means Annual Percentage Yield. APY is accurate as of {todayDate}. Interest rate and APY may change after initial deposit depending on the terms of the specific product selected. Minimum opening deposit is $1.00.

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