When it comes to saving money, you might shop around before choosing an account where you want to deposit your money. When you do, ‘Interest Rate’ and ‘APY’ are words you will see and hear as you look at deposit products such as savings accounts, money markets, and certificates of deposit (CDs). Knowing the difference between interest rates and APYs can help you better understand savings products and make better decisions for your money.
Before going further, you should know that interest rates apply to many types of accounts – including savings products, loans, and credit cards – but for the sake of this article, we’ll focus on how interest rates apply to deposit accounts.
What is an interest rate?
When you keep money in a deposit account at a financial institution, the financial institution can allow others to borrow the money, and because of that, you may be paid interest on that money. How much you are paid for your deposits is determined by a calculated percentage known as the interest rate.
If you’re comparing savings accounts or CDs, you might look at the interest rates and assume the higher the rate, the better, right? There’s actually more to it. The interest rate doesn’t give you the entire picture. You need to look at the type of interest paid – simple or compound – and how frequently the interest is applied to your account. You should also consider any terms and fees applied to the account.
What is the difference between simple interest and compound interest?
Simple interest and compound interest determine how quickly the money in your deposit account will grow over time. With simple interest, you multiply the total balance in your account by the interest rate for that account. Compound interest can grow your money more quickly because you earn interest over set intervals of time and the interest you earn is added to the balance.
Interest could compound daily, weekly, monthly, quarterly, or annually. The more often your money compounds, the more you can earn because you are not just earning interest on what you’ve deposited, you’re also earning interest on the interest you’ve already earned. So, an important part of compound interest is understanding how often interest is calculated and applied to your account.
What does APY stand for and what does it mean?
APY stands for “annual percentage yield”. APY is a measurement for the amount of interest you earn when you keep your money in a deposit account over the period of one year. In most cases, the higher the APY, the more money you will gain in your account during that year. Make sure to consider how much money you have in your deposit account and the fees on that account, both of which can determine how much you may earn.
Will the APY on a deposit account change?
The APY on deposit accounts may be fixed or variable. A fixed APY generally won’t change until funds are held for a designated length of time. This is the case with most CDs, or time-based accounts. However, most deposit accounts are not time-based and have a variable APY. A variable APY is more likely to change and can go up and down based on the economic market.
Which is more important, interest rate or APY?
When shopping for a deposit account, you should really be looking at the APY. The APY is based on the interest rate, but APY calculations also consider the type of interest – simple or compound – and the frequency at which interest compounds during the year. Because it takes compounding into consideration, it’s better to compare APYs when deciding between multiple deposit accounts. The higher the APY, the more you may earn and the more quickly the money you deposit may grow. However, when comparing accounts, don’t forget to also consider any fees or additional terms an account may have as those can affect how quickly your money grows.
If you’re interested in learning more, visit your nearest First Mid banking center today to discuss your options. You can also start your savings today by opening a Retail Savings or Retail Money Market account online.