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Guide to Annual Percentage Yield (APY): How Is It Calculated?

What Is Annual Percentage Yield (APY)? Calculating It
Jennifer Calonia
Jennifer CaloniaUpdated March 9, 2023
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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
Annual percentage yield, or APY, tells you how much you can earn in a year on an account that pays interest. It includes the effect of compounding (when your interest also earns interest) to give you a true picture of how much you’ll earn as your account grows over the course of a year.Understanding APY can help you get the best possible return on your savings. Read on for a closer look at how APY works, including how it’s calculated and what it can tell you about different types of savings accounts.

What Is Annual Percentage Yield? 

By definition, APY is the amount of money (or interest) you earn on a bank account over the course of one year. It’s expressed as a percentage, such as 2.00% APY. Unlike simple interest, which is the interest you earn on the money you put into the account (known as the principal), APY includes compound interest. Compounding simply means adding the interest you've earned to your principal balance. For example, if you earned $3 on your $300,000 balance today, tomorrow you will earn interest on $300,003. Depending on the account, interest may be compounded daily, monthly, or annually. The greater the number of compounding periods, the greater the compound interest will be. 

How Does APY Work? 

APY is the interest calculated on both the principal and the accumulated interest from previous periods. By telling you how much you stand to earn on the account in one year, APY enables you to compare savings accounts apples to apples without having to calculate interest, plus compounding, on your own.The types of bank accounts that offer APY on deposits include:APY can be fixed or variable. With a savings or money market account, the APY is usually variable, which means the APY you start out with could change. It might go up or it might go down depending on the actions by the Federal Reserve (a.k.a, “the Fed”). If the Fed increases its benchmark interest rate, the APY on your savings accounts will typically follow suit. If it lowers rates, you'll generally see APYs on savings accounts go down as well.By contrast, CDs typically offer a fixed APY.

Calculating Annual Percentage Yield

Below is the mathematical formula for calculating an APY.APY = (1 + r/n)n - 1 In which:r = interest rate (expressed as a decimal)n = the compounding periods per year (if interest is compounded monthly, this would be 12; if it’s compounded daily, this would 365)While it’s helpful to know what goes into the APY calculation, the good news is that you don’t have to do any complicated math to come up with an account’s APY. The bank or credit union will typically publish an account's APY. You can also use one of the many free APY calculators available online.

What Information Does Annual Percentage Yield Give?

An APY tells you at a glance how much your money could grow over a year. Since it includes the effect of compounding, it makes it easy to compare offerings from different financial institutions. Generally, the higher the APY, the faster your money will grow.However, APY doesn’t tell you everything. You’ll also want to take a look at account fees (which can eat into any interest you earn) and any minimum balance requirements. In some cases, you may only be able to earn the advertised APY if you keep a certain minimum balance in the account or a certain combined balance across your accounts with the same bank.

How Annual Percentage Yield Can Affect Your Returns

APY includes the impact of compounding interest, which can have a significant effect on your returns. Here’s a closer look at how compounding works.Let’s say you put $10,000 into a savings account that pays an interest rate of 4.00% that compounds annually. After one year, you’ll earn $400. But what if that interest rate compounded monthly? In that case, you would earn 407.42. While the difference isn’t large over one year, compounding has a greater impact over time. After 10 years, that initial deposit of $10,000 would be $14,908.33 (assuming you didn’t deposit a single extra dollar during that time) with monthly compounding. With annual compounding, you would have $14,802.44.

Tips for Finding the Best APY 

When looking around for a competitive APY, here are a few tips to keep in mind.
  • Consider an online bank. Online-only institutions typically offer higher APYs for savings accounts than banks with brick-and-mortar locations due to lower overhead costs. 
  • Find out if it’s an introductory rate. In order to attract new customers, banks may offer an attractive promotional APY that’s only good for a certain period of time. When the introductory period ends, the rate will drop. Check to see if the advertised APY is ongoing or temporary.
  • Check if the rate is flat or tiered. Some banks offer a flat APY — you earn this no matter how much you have in your account. Others offer a tiered rate structure that rewards account holders with higher balances with a higher APY.
  • Watch out for fees. If you find an account offering a high APY but it charges a monthly maintenance fee, that will cut into any interest you earn.
Recommended: Guide to Opening a Savings Account Online 

Special Considerations

APYs can vary widely by bank. For example, online banks tend to offer higher APYs than traditional banks. They can also vary by bank account type. Money market accounts, high-yield savings accounts, and certificates of deposit (CDs) typically offer higher APYs than regular savings accounts.  Recommended: What is the Average Interest Rate on a Savings Account? 


Although they sound similar, an APY is different from an APR, which stands for annual percentage rate. An APY is how much interest you can earn on a bank account, whereas an APR is how much interest you’ll pay to borrow money.A loan's APR is the cost of the loan expressed as an annual rate when the interest rate plus fees (such as origination fees and application fees) are factored in. APR is used in reference to everything from mortgages and auto loans to credit cards. It allows consumers to compare loans apples to apples, since fees are taken into account.Like APYs, APRs can be fixed or variable. Fixed rates are common with mortgages, while credit cards typically have variable APRs.While a higher number is better with APY, a lower number is better with APR, since it means you’ll pay less interest over the life of the loan. Borrowers with strong credit histories tend to qualify for lower APRs. By contrast, credit scores have no bearing on APYs.Recommended: How Do Banks Make Money and Generate a Profit?

APY vs Interest Rate

A savings account’s interest rate may not be the same as its APY. The reason is that the interest rate doesn’t tell you how frequently the interest compounds. The account’s APY, on the other hand, includes both the interest rate and compounding interest, to give you the actual amount you can earn in a year.

Dividend Rate vs APY

A “dividend rate” is the term credit unions use to tell customers (called “members”) the annual rate of interest they will earn on a deposit account. The dividend rate doesn't account for compounding, however. Credit unions will also typically publish an account’s APY. The APY accounts for the dividend rate as well as how frequently interest is compounded, and represents your potential dividend earnings over one year.

The Takeaway

APY can help you understand exactly what you’ll earn in a savings account over one year because it takes compound interest into account. It’s a useful number to look at when you’re comparing different types of interest-bearing accounts, such as savings accounts, money market accounts, and CDs.If you’re looking for a better return on your savings, it can be helpful to use a bank comparison site that lists the APYs currently being offered by different institutions. With Lantern by SoFi’s online banking marketplace, for example, it’s fast and easy to compare high-yield savings accounts based on APY, fees, and balance minimums. Lantern can help you compare online savings accounts and find today’s best rate.

Frequently Asked Questions

What APY rate can be considered good?
How can I, as an investor, use APY to my advantage?
Is APY variable or fixed?
Is APY better than APR?
Photo credit: iStock/shih-wei

About the Author

Jennifer Calonia

Jennifer Calonia

Jennifer Calonia is a Los Angeles-based finance writer who has covered the gamut, including student loans, credit card rewards, consumer loans, and debt. Her work has been featured in outlets like Bankrate, NerdWallet, Business Insider, Yahoo Finance, and U.S. News.
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