Banks quote two different numbers that both look like "the rate": the interest rate and the APY. They're close, but they're not the same, and knowing which is which keeps you from comparing apples to oranges.
The short version
- Interest rate is the simple annual rate the bank pays on your balance, before compounding.
- APY (annual percentage yield) is what you actually earn over a year including compounding, meaning interest earning interest.
APY is always equal to or higher than the interest rate. The more often interest compounds, the bigger the gap.
A concrete example
Say a savings account pays a 4.26% interest rate, compounded daily.
Each day you earn 4.26% ÷ 365 of your balance. That interest gets added to your total, so the next day's interest is calculated on a slightly bigger number. Repeat for a year and $10,000 grows to about $10,435, a gain of 4.35%, not 4.26%.
That 4.35% is the APY. Same account, two numbers: 4.26% interest rate, 4.35% APY.
Which number should you use?
Always compare savings accounts by APY. It's the standardized, all-in number; U.S. banks are required to disclose it precisely so that shoppers can compare fairly, regardless of whether an account compounds daily, monthly, or quarterly.
For loans, the equivalent all-in number is APR (which folds in certain fees). The rule of thumb:
| You're shopping for | Compare using |
|---|---|
| Savings account or CD | APY (higher is better) |
| Loan or credit card | APR (lower is better) |
Why banks quote the one they quote
Marketing follows incentives. Savings products are advertised by APY because it's the bigger number. Loans sometimes lead with the bare interest rate because it looks smaller than the APR. Neither is deceptive on its own (the regulated disclosure is always available), but it's worth noticing which number a headline is showing you.
Three takeaways
- APY includes compounding; interest rate doesn't.
- Compare like with like: APY against APY, APR against APR.
- Compounding frequency barely matters once it's reflected in APY: a daily-compounding 4.30% APY account and a monthly-compounding 4.30% APY account pay you the same.
Once you're fluent in the two numbers, picking an account is mostly a matter of finding a strong APY with no fees; our current picks are here.
