APY Meaning: What You Need to Know

Milana Budisavljevic, PBO Manager, First Republic Bank
December 10, 2021

Business and personal banking often allows you to earn interest on the money deposited into your interest-bearing account. So you may have heard of an annual percentage yield, or APY, and be asking yourself: what is APY?

The good news is that the APY definition is pretty straightforward: an APY is the actual amount of return you make on your account. Unlike interest rate calculations, the APY calculation means taking compound interest (or compounding interest) into consideration. So, for example, APY compounding periods would factor into the amount of money in your bank account plus the amount of money you would make on interest, compounded by the money you earn along the way via interest.

This is just the beginning of what you need to know about the APY. Read on for more about how APY calculations work, how to calculate APY yourself and how APY differs from that of APR (annual percentage rate). Your savings accounts, investments and debts depend on knowing the difference between both, as well as the role interest plays.

What is APY, and how does it work?

An annual percentage yield, or APY, provides you with a better understanding of how much compounding interest you stand to make within a year. APY calculations help standardize the rate of return you’ll get by stating the real percentage of growth you’ll earn in compounding interest — so long as you keep the money in the account for a year, of course.

APR vs. APY vs. interest rate

APY is different than the APR since the APR reflects what you as a borrower will make in interest payments based on the balance of your loan. Therefore, the APR is a calculation that tallies the total interest you’ll owe on your balance as you pay it off, rather than what you’ll earn in interest on a deposit account. Similar as they might sound, they are significantly different in terms of how they affect your finances.

APY, APR and interest rate are all different financial figures that help you understand the interest you might earn or owe on a deposit account balance or loan, respectively. However, each term means something slightly different, and both APY and APR are calculated differently. Here’s what you need to know about each:

 APY APR Interest Rate Measures the total amount of interest you’ll receive on your account balance in a 12-month period The interest rate charged on a loan is reflected as a yearly percentage. The percentage of the money you owe on top of your loan balance The percentage you’ll earn from a deposit account, depending on your underlying balance. Interest rates also calculate the amount of additional money you may owe a lender on top of the balance of money you’ve borrowed

How to calculate APY

You can easily learn how to calculate APY if you know your account’s interest rate and its compounding frequency (the number of times your bank, financial institution or lender pays you interest on your account balance). The APY is often a more useful measure of how much money you stand to make in terms of your interest rate on top of your underlying balance.

 APY Formula APY = (1 + r/n)n + 1 r = Interest rate n = Number of compounding periods

Why is APY important?

Your account’s APY is a key indicator of how much money you’ll be able to earn when you invest your money. APY helps you account for compounding interest, and doing so gives you a better sense of how much you’ll earn in interest based on your account balance. You should consider the APY being offered on the following compounding interest accounts:

• High-yield savings accounts
• Money market accounts
• Certificates of deposit

Calculating APY makes it easier for you to quantify how much you may stand to make by way of interest, and doing so can help you better plan for your account balance on a recurring basis. This also means you can keep an eye on how compounding interest helps you grow your money without requiring work on your part to do so. 