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APY vs. Interest Rate: What’s the Difference?
The terms are sometimes used interchangeably, but APY and interest rate are different thanks to compound interest.
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When dealing with interest-bearing bank accounts, it’s important to understand the difference between annual percentage yield (APY) and interest rate. The two are similar, but they’re not exactly the same. Knowing the distinction between the two terms will help you know how much return to expect on your deposits and investments.
Here’s what you need to know about APY vs. interest rate.
APY reflects the total amount of interest you earn on money in an account over one year, while an interest rate is the rate at which interest is earned on the original amount. Both are expressed as percentages.
The key difference between APY and interest rate is compound interest.APY includes interest that’s earned on the original balance as well as the amount of compound interest earned in one year. Interest rate only accounts for interest earned on the original amount.
4.50%SoFi members with direct deposit activity can earn 4.50% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. There is no minimum direct deposit amount required to qualify for the 4.50% APY for savings. SoFi members with Qualifying Deposits can earn 4.50% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that are equal to or greater than $5,000 every 30 days. Members without either Direct Deposit or Qualifying Deposits will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Interest rates are variable and subject to change at any time. These rates are current as of 8/2/2023. There is no minimum balance requirement. Additional information can be found at http://www.sofi.com/legal/banking-rate-sheet.
These cash accounts combine services and features similar to checking, savings and/or investment accounts in one product. Cash management accounts are typically offered by non-bank financial institutions.
These cash accounts combine services and features similar to checking, savings and/or investment accounts in one product. Cash management accounts are typically offered by non-bank financial institutions.
5.50%*Base annual percentage yield (variable) is 4.75% as of 7/31/23. 5.50% APY reflects a .75% boost available as a special offer with qualifying deposit. Terms apply. Cash Reserve is only available to clients of Betterment LLC, which is not a bank, and cash transfers to program banks are conducted through clients’ brokerage accounts at Betterment Securities.
Min. balance for APY
$0
CDs (certificates of deposit) are a type of savings account with a fixed rate and term, and usually have higher interest rates than regular savings accounts.
CDs (certificates of deposit) are a type of savings account with a fixed rate and term, and usually have higher interest rates than regular savings accounts.
0.50%SoFi members with direct deposit activity can earn 4.50% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. There is no minimum direct deposit amount required to qualify for the 4.50% APY for savings. SoFi members with Qualifying Deposits can earn 4.50% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that are equal to or greater than $5,000 every 30 days. Members without either Direct Deposit or Qualifying Deposits will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Interest rates are variable and subject to change at any time. These rates are current as of 8/2/2023. There is no minimum balance requirement. Additional information can be found at http://www.sofi.com/legal/banking-rate-sheet.
Which one is important to know for savings accounts?
While financial institutions are required to show rates as APY, they can also show the corresponding interest rate. When it comes to your savings account, it’s more important to know the APY, because knowing the rate that includes compound frequency (that is, how often interest is paid) will give you more precise information about how much interest you will earn within the year.
Example of the difference between APY and interest rate
Here’s an example showing how APY is different from interest rate:
Suppose you have $10,000 and earn an interest rate of 4.17% at a bank, paid after one year, without compounding. The amount of interest you earn is $417 ($10,000 x 4.17% = $417).
Now, instead of waiting one year, suppose the bank deposits a proportional share of the interest earned after one month (that is, 1/12th of the 4.17% APY). This means the total bank balance will be a little more than $10,000: $10,034.75.
After the next month, the bank deposits another proportional share of interest. When that happens, the interest earned the previous month compounds, meaning that it also earns interest. So in the second month, you’re earning interest on $10,034.75. At the end of the second month, you’ll earn $34.87 in interest and the total bank balance will be $10,069.62.
If the interest continues to compound each month at the same rate, then at the end of one year, the account would actually earn about $425. This means that with compounding, the APY would be around 4.25% ($10,000 x 4.25% = $425). You can use a savings calculator to calculate balance amounts and try other scenarios with daily, monthly and annual compounding.
So in this example, where interest is compounded monthly, the interest rate is 4.17% and APY is 4.25%.
APY to interest rate calculator
Use this calculator to convert an APY to an interest rate and see how the rates differ.
Frequently asked questions
What’s the difference between APY and interest rate?
The difference between APY and interest rate is that APY includes compound interest, and interest rate doesn’t.
Why is APY higher than the interest rate?
APY is higher than the corresponding interest rate because APY includes interest on the original amount and compound interest. In contrast, the interest rate only features interest on the original amount, with no compounding interest.
What’s the difference between APY and interest rate?
The difference between APY and interest rate is that APY includes compound interest, and interest rate doesn’t.
Why is APY higher than the interest rate?
APY is higher than the corresponding interest rate because APY includes interest on the original amount and compound interest. In contrast, the interest rate only features interest on the original amount, with no compounding interest.
