APY Vs. Interest Rate: What’s The Difference?

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

APY vs Interest Rate Comparison

FactorAPYInterest Rate
DefinitionEffective annual rate of return accounting for compoundingNominal rate of interest charged or earned
CompoundingIncludes compounding effectsDoes not include compounding
UsageMore common in savings and investmentsOften used in loans and simple investments
FrequencyVaries (can be daily, monthly, yearly)Typically expressed as an annual rate

What is APY?

Annual Percentage Yield (APY) refers to the real rate of return earned on a savings deposit or investment, taking into account the effect of compounding interest. Unlike simple interest, APY includes additional earnings from the principal amount being reinvested.

What is Interest Rate?

Interest Rate, often just called the “nominal interest rate”, is the percentage charged on the total amount borrowed. It doesn’t factor in compounding within a specific period. It’s the basic rate charged on a loan or earned on an investment.

Key Differences Between APY and Interest Rate

  1. Compounding Interest: APY takes into account compounding, while the interest rate does not.
  2. Earnings/Charges: APY reflects the total amount of interest earned or paid annually, whereas the interest rate shows the basic cost of borrowing money.
  3. Frequency of Compounding: The more frequently interest is compounded, the higher the APY will be compared to the nominal interest rate.

Examples

  1. Savings Account: An account with a 1% interest rate compounded monthly will have an APY higher than 1%.
  2. Loan Scenario: A loan with an annual interest rate of 5% but compounded monthly will have an APY higher than 5%.
Apy Vs Interest Rate

Conclusion

Understanding the difference between APY and interest rate is crucial for financial decision-making. APY offers a more comprehensive understanding of potential earnings or costs due to its inclusion of compounding interest. For more detailed insights and to discuss which option suits your financial needs best, contact us today for a free quote.

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Frequently Asked Questions

How does compounding affect APY and interest rates?

Compounding increases both APY and interest rates over time.

Is APY higher than the Interest rate?

APY can be higher than the interest rate due to compounding.

What is the difference between APY and interest rate?

The difference between APY and interest rates lies in how they are calculated. While the interest rate refers to the percentage charged on a loan or earned on an investment, the APY (Annual Percentage Yield) takes into account compound interest, giving a more accurate representation of the overall return. APY is typically higher than the interest rate due to compounding effects.

What does APY mean on a cd?

APY stands for Annual Percentage Yield. It is a measure used to calculate the total amount of interest earned on a certificate of deposit (CD) in a year, taking into account compounding. APY reflects the actual return on investment and is important for comparing CD offers from different banks.

Shawn Plummer, CRPC

Chartered Retirement Planning Counselor

Shawn Plummer is a Chartered Retirement Planning Counselor, insurance agent, and annuity broker with over 14 years of first-hand experience with annuities and insurance. Since beginning his journey in 2009, he has been pivotal in selling and educating about annuities and insurance products. Still, he has also played an instrumental role in training financial advisors for a prestigious Fortune Global 500 insurance company, Allianz. His insights and expertise have made him a sought-after voice in the industry, leading to features in renowned publications such as Time Magazine, Bloomberg, Entrepreneur, Yahoo! Finance, MSN, SmartAsset, The Simple Dollar, U.S. News and World Report, Women’s Health Magazine, and many more. Shawn’s driving ambition? To simplify retirement planning, he ensures his clients understand their choices and secure the best insurance coverage at unbeatable rates.

The Annuity Expert is an independent online insurance agency servicing consumers across the United States. The goal is to help you take the guesswork out of retirement planning and find the best insurance coverage at the cheapest rates

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