Cash News
There are a lot of good reasons to deposit your money into a bank account. For one, you don’t have to worry about having your paper cash lost, stolen, or burned in a fire. Perhaps a more practical reason, though, is that you earn interest on the money. Think of that interest as the bank’s way of paying you to borrow your cash.
How much will your deposits earn? That part can be hard to figure out. While it’s natural to look at the interest rate to estimate what the bank will pay you, annual percentage yield (APY) is a more accurate measure.
APY vs. interest rate
Interest rate and (APY) can both refer to the money you earn on your deposits over the course of a year, but they’re not the same thing. With interest, also known as simple interest, you earn a flat percentage of the original amount you deposit, not your full balance.
For example, if you deposit $1,000 and earn $1 in interest in the first month, your balance is now $1,001. But in the second month, you will only earn interest on the $1,000 you deposited, not the full $1,001 balance.
With APY, however, you earn interest on both your deposit and on the interest you’ve already accumulated.
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Interest: The flat rate you earn on your deposits only, not on your full balance.
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Annual percentage yield (APY): The rate you earn on your total balance, including your deposits and the interest you’ve already earned. This is also known as compound interest.
When you deposit money to an account that earns APY, you get the benefit of compound interest, meaning your interest will earn interest. Depending on the account, the interest will compound daily, monthly, or annually. The more frequently it compounds, the more money you can earn. Here’s a comparison of how much you’d earn with different compounding periods at a 5% fixed rate:
As you can see, there’s not necessarily a big difference in what you earn with a simple interest rate vs. APY — at least not when it comes to small deposits and short timeframes. But those differences are accelerated when you make larger deposits and/or you leave the money in your account for a longer period.
For example, a $20,000 deposit that earns 5% simple interest will earn $5,000 in interest over five years, while the same deposit at 5% daily compound APY will earn $5,680.07.
What types of accounts earn APY?
For accounts where you can deposit and withdraw money — also known as deposit accounts — you typically earn APY. These include:
With the exception of CDs (which earn a fixed rate), deposit accounts usually come with variable interest rates, meaning the rate can change from time to time at the bank’s discretion. So, your APY might go up or down depending on factors outside of your control, such as market conditions and the Federal Reserve interest rate. However, you’ll never lose money in your account due to changing rates and APYs.
How can I earn a higher APY?
The best way to earn a higher APY is to shop around for an account that offers a high rate. Here are some features to look for:
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Type of financial institution: Online banks and credit unions typically offer higher APY than traditional banks.
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Account type: Checking accounts don’t always pay interest. For the highest rates, you usually have to look to CDs, money market accounts, or HYSAs.
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Compounding periods: The more frequently the balance compounds, the more interest you’ll earn.
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Balance requirements: You might have to make a large minimum deposit or maintain a high minimum balance in order to qualify for the highest APYs, though that’s not always the case.
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Account tiers: Some deposit accounts have different rates that apply to certain deposit amounts. For example, the first $1,000 might earn a higher APY.
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Fees: Account fees are not figured into the APY. So if you have to pay a monthly account maintenance fee, your earnings will be less.
Read more: 17 savings accounts that pay 5% APY or higher
Is interest rate or APY more important when choosing an account?
APY is a more accurate reflection of the returns you earn on your deposit accounts, including savings and CDs, since it takes compound interest into account. So when you’re comparing deposit accounts, APY is a more important comparison.
One way APY falls short, however, is that it doesn’t take fees into consideration. Even if you deposit your money into an account with high APY, you could end up losing money if you pay frequent or substantial bank fees.
Frequently asked questions (FAQ)
What’s the difference between APY and APR?
Annual percentage yield (APY) and annual percentage rate (APR) are both related to interest. However, APY represents the compounding interest you earn on your account balance, while APR represents a combination of the interest and fees you pay on debt, such as credit cards and loans.
Why does my account have multiple APYs?
Your account may have multiple APYs because it’s a “tiered-rate account.” These accounts have different rates that apply to different balance amounts. Usually, the highest APY applies to a limited portion of your balance. For example, the first $5,000 in deposits may earn 5% APY while the remaining balance, regardless of how much it is, earns 2%.
Why isn’t my account earning interest?
There could be a few reasons your account is not earning interest. The most likely reason is that your account doesn’t come with this benefit. This issue is most common for checking accounts. For CDs, your account will stop earning interest after it reaches the maturity date unless you or the bank rolls the money into a new CD.
How can I find the APY on my account?
When you’re researching an account, you might find the APY information in the bank’s advertisements or on their website. For accounts you already have open, you can look in the Truth is Savings disclosure or on your bank statements to find the APY.