Is a higher APY always better?

For savings, yes. A higher APY means you earn more on your deposits. However, also consider factors like account fees, minimum balance requirements, and withdrawal limits. A slightly lower APY with no fees may net you more than a higher APY with monthly charges.

Does APY apply to loans too?

For loans, the equivalent metric is APR (Annual Percentage Rate), not APY. APR includes fees and costs of borrowing. APY is used for deposit products to show what you earn. The two metrics are related mathematically but serve different contexts.

Can APY change over time?

Yes. Most savings accounts have variable APY that can change when the bank adjusts its rates, often in response to Federal Reserve actions. Fixed-rate CDs lock in the APY for the certificate term. Always check whether the quoted APY is variable or fixed before opening an account.

What Is APY vs Interest Rate

When comparing savings accounts or certificates of deposit, you will encounter two numbers: the interest rate and the APY. They look similar but mean different things, and understanding the distinction helps you choose the account that actually earns you more money. Project your earnings with the Savings Calculator.

What Is APY

APY stands for Annual Percentage Yield. It represents the total amount of interest you earn on a deposit over one year, taking into account the effect of compounding. If your account compounds interest monthly, the APY will be slightly higher than the nominal rate because each month's interest starts earning its own interest in subsequent months. APY gives you a single, standardized number that reflects your true annual return.

How APY Differs from the Nominal Rate

The nominal interest rate, also called the stated rate, is the base percentage applied to your balance before compounding is considered. A 4 percent nominal rate compounded monthly means 0.3333 percent is applied each month. Over the year, the cumulative effect produces slightly more than 4 percent in total return. Specifically, the APY works out to about 4.074 percent. The difference grows with higher rates and more frequent compounding.

Banks are required to disclose APY so consumers can make apples-to-apples comparisons. Two accounts with the same nominal rate but different compounding schedules will have different APYs. The one that compounds more frequently will always have the higher APY and earn you more money, as explored in our guide on growing savings with regular deposits.

Why Banks Advertise APY

Banks prominently display APY because it is always equal to or higher than the nominal rate, making their offering look more attractive. This is not deceptive; APY is genuinely the more useful number for savers because it reflects what you actually earn. When shopping for a savings account, always compare APY to APY, not nominal rate to APY. Mixing the two metrics leads to inaccurate comparisons.

Brief Example

Account A offers 3.9 percent nominal compounded daily. Account B offers 4.0 percent nominal compounded annually. Account A's APY is approximately 3.977 percent (daily compounding on 3.9 percent), while Account B's APY is exactly 4.0 percent (annual compounding means nominal equals APY). Despite having a lower nominal rate, Account A's frequent compounding narrows the gap, but Account B still wins with the higher APY. Always use APY for the final comparison.

Practical Takeaway

When evaluating savings products, focus on APY rather than the nominal interest rate. APY accounts for compounding and tells you the true yield on your deposit. Use the Savings Calculator to project how different APY values translate into actual earnings over your savings timeline.