What is an annual percentage yield (APY)?

APY Explained

Most people who have borrowed money in the past two decades are familiar with the term APR (Annual Percentage Rate) and its implications. It displays the true interest rate you’re paying for the loan to which it applies. A more recent term, APY (Annual Percentage Yield) displays the true interest rate you’re earning for the account to which it is attached.

For example, a savings account paying 4.0% interest may actually be earning you more interest than the stated rate. Assume you deposit $5,000 in two accounts both paying 4.0% interest. One account posts interest once per year, on December 31. That account will earn you $200.00 for the year and your APY is 4.0%.

The second account, however, posts interest quarterly during the year. Through this quarterly posting and the magic of “compounding” (earning interest on interest), you’ll earn around $203.03 for the year. Your true earnings rate or APY is around 4.1% for the year.

APY calculations give you a better idea of what a certificate of deposit (CD), savings, checking, or money market account is really earning. In some cases, a stated rate of interest may be higher than an APY, but this situation is rare.