How does APY work? (Annual percentage yield)

February 07, 2022

By Katie Levene

How does APY work? (Annual percentage yield)

Annual percentage yield is important when choosing a deposit account.

When opening a deposit bank account, it’s important to know that not every account is the same. You want an account that will be easy to use and will help your money earn more money. The easiest way for you to do this is to earn interest on that account every month. Compound interest is your friend, which is why annual percentage yield (APY) is so important.

The official APY definition is the interest rate (aka “rate of return”) on a deposit account based on a compounding period of one year. The simple definition is that APY is the total amount of interest received when you leave your funds in the account for one year. It is pretty simple to calculate your APY.

How is APY calculated?

The APY percent varies depending on the financial product and your financial institution. Many factors go into Alliant's rates, including our current financial position, our competition, and the Federal Reserve rates. As a financial institution, we are focused on providing superior rates for our members and our high APY on deposit accounts reflects that.

The more money you have and the higher the annual percentage yield, the more you will receive in interest.

If you have money in an account, you want it to make money. This philosophy should apply to all of your deposit accounts regardless of liquidity. That said, APY applies to all deposit accounts. This includes checking, savings, certificates and certificates of deposit, and money market accounts.

What is the difference between the Interest Rate and APY?

When you first start comparing deposit accounts, you'll notice two different interest acronyms listed on some products. The percentages were similar, so it can confusing as to why you'll see an APY and the Interest Rate.

In short, for a deposit account, the Interest Rate is the percent return without compounding interest included. It is also known as simple interest. The APY is the total amount of interest received when you leave your funds in the account for one year. APY is the percent return including compound interest after a year.

Think of it this way. You have $20,000 in a savings account for a year. The rate is 2.08%. If you do the math ($20,000 x 2.08%), you get $416 in interest earned. You have a total of $20,416.00 in your account. However, this number is wrong because it doesn’t take compound interest into account.

The frequency of compounding interest is important. At Alliant Credit Union, your savings account is compounded monthly. Therefore, at the end of the year, you actually have about $20,420.00 in your savings account. Your account has increased by 2.10% APY in a year. This percent is your APY. Banks use APY to show the actual interest increase if you kept the money in the account for a year. So, the math is simple and most of the time, you don't even need a calculator for APY.

Note: APY and APR are different. You'll notice APR referenced on loans such as credit cards and personal loans.

Why is annual percentage yield important?

Let’s use an example to illustrate why a high APY is important. Say you have $10,000 in a savings account. At 0.08% APY, your $10,000 will become $10,008.00 after compounding monthly for a year. In a high-rate savings account at 1.00% APY, that $10,000 will become about $10,100.00 after compounding monthly for a year. The effect of compound interest on your deposit accounts can be huge beyond 12 months.

When choosing your financial products, open an account that will earn more money on your money.

What is a high rate?

Now that you understand APY better, you probably want to make sure you have a high annual percentage yield.

APY rates are very dependent on the credit union or bank you choose. Not every account pays interest. The average APY for a savings account is almost zero according to the New York Times. However, there are many options that pay more, including high-rate savings accounts. These accounts offer an above-average APY percentage.63

The average checking account APY, according to Bankrate, is low at .04% APY. Again, a high-rate checking offers a better rate.19

Certificate and CD APYs will depend on the amount you put into your account and the timeline. Certificates typically give you an even better interest rate on your money than in a savings account. However, you can’t withdraw the money for an extended period. Certificate APYs vary, so it’s important to do your research.

Alliant offers a high-rate savings account! Learn more about our award-winning account.

Katie Levene is a marketer fascinated with finance. Whether the topic is about the psychology of money, investment strategies or simply how to spend better, Katie enjoys diving in and sharing all the details with family, friends and Money Mentor readers. Money management needs to be simplified and Katie hopes she accomplishes that for our readers. The saying goes, "Knowledge is Power", and she hopes you feel empowered after reading Money Mentor.

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