Understanding APY and Its Importance

You have likely seen banks and credit unions advertise annual percentage yields or APYs. An APY is expressed as a percentage, similar to an interest rate, but there is a distinct difference between the two. Your interest rate represents the amount you will earn on your initial deposit into a bank account, but your APY is more comprehensive than that. Understanding how APYs work and why they matter can help you make better financial decisions. Here is what to know about these percentages and their impact on your savings.

What is APY?

An interest rate on a deposit account represents the interest earned on your balance, while APY accounts for both deposits and interest earned over a year.

When you deposit money into an interest-bearing bank account, interest earnings are added to your balance, typically once a month. You then earn interest on both your balance and those earnings - this is called compound interest. Since APY factors in compounding, it provides a more accurate measure of your potential earnings over a year than the account's interest rate.

Banks and credit unions determine a deposit account’s APY using this calculation:

APY = ( 1 + r ⁄ n ) n – 1
r = interest rate
n = annual compounding periods

For example, if a CD account has a 3.75% interest rate (r) and compounds interest 12 times a year (n), the APY would be 3.81%. While manual calculation is an option, an APY calculator can simplify the process.

You will generally see banks advertise their APYs on savings accounts, certificates of deposit (CDs), money market accounts, and occasionally checking accounts. However, many checking accounts do not earn interest.

APY vs. APR

While similar in name, APYs differ from annual percentage rates (APRs). An APY is associated with savings and investment accounts and represents compound interest earnings over a year. A high APY on a deposit account is beneficial, as it means you are likely to earn more interest on your money.

By contrast, an APR is associated with loans and credit products, including auto loans, credit cards, personal loans and home equity lines of credit (HELOCs). It represents total borrowing costs over a year. APRs typically include interest rates plus any fees associated with a loan or credit account. A high APR is not beneficial, as it means you are likely to pay high borrowing costs.

Interest rates factor into both APYs and APRs. Your interest rate on a savings or investment account does not take compound interest earnings into account like your APY. Your interest rate on a loan or credit line does not account for fees like your APR.

Understanding how APY and APR work is an important part of financial planning. In general, a high APY on a deposit or investment account is a benefit, while a high APR on a loan or credit account is not.

Here are a couple of examples highlighting the difference between APY and APR:

You open a CD with a 3.81% APY and deposit $5,000. After one month, you’ll earn $15.88 in interest and after one year, your account balance will be $5,194 thanks to compounding interest.

You apply for a $5,000 loan with an 8.75% APR and a two-year term. Your monthly payment will be approximately $228 and you will pay a total of $468 in interest over your loan’s term.

Why APY Matters

Your APY plays a critical role in your savings growth, and as mentioned, a high APY will generally result in more interest earnings. CDs and money market accounts tend to have the highest APYs among deposit accounts, though high-yield savings accounts also offer generous APYs. Most checking accounts don’t earn interest, as they serve as accounts for daily spending.

Once you determine your needs, you can start shopping around to find an account with a high APY. You will also want to consider whether there are fees associated with each account. Monthly maintenance fees, for example, are common among savings accounts. If you’re shopping for a new savings account, Seacoast Bank offers a broad range of options - many of which have no monthly maintenance fees if you meet the minimum balance requirements.

How to Maximize Your APY

Keep in mind that APYs can change over time depending on broader market conditions and rates. Certain types of savings products may have different APYs, too, with certificates of deposit (CDs) and money market accounts (MMAs) offering some of the most generous rates. Here is how each product works:

• Savings account: A savings account is ideal if you want an easily accessible account with a modest APY to grow your savings. Many savings accounts allow you to withdraw money as needed, though some have transaction limits related to dollar amount or frequency. APYs on savings accounts fluctuate and may sometimes be lower than CDs or MMAs.
• CD: A CD is ideal if you want a high APY and are comfortable leaving your money invested for a set period. Banks may offer CD terms as short as a few months or as long as several years. When you open a CD at a certain rate, that rate will remain the same for the duration of your term. CDs often have early withdrawal penalties so make sure you won’t need that money for the investment period.
• MMA: An MMA is ideal if you want a high APY and easy access to your money. This account is unique because it has features of both checking and savings accounts. For instance, you may get a debit card with an MMA, though these accounts often have monthly transaction limits.

If you decide that a savings account with a generous APY is your best option, you can maximize your interest earnings by making regular deposits. Consider automatically funneling a portion of each paycheck into your new savings account and letting it grow over time. You might be pleasantly surprised how much your balance grows in a relatively short time period.

Conclusion

While they are all expressed as percentages, interest rates, APRs and APYs differ. Interest rates don’t tell the whole story of how much you’ll pay for a loan or credit line or how much you’ll earn from a deposit account. APRs provide a more comprehensive picture of your borrowing costs, while APYs give you more insight into potential interest earnings on your deposits.

Understanding how APYs work can help you along as you shop for a new deposit account. Typically, you will earn more interest with a higher APY. That said, you’ll also want to consider which account best suits your needs and keep fees in mind, as these costs could erode any potential earnings.

If you’re shopping for a new savings account with a generous APY, explore Seacoast Bank’s savings options. If you have questions about managing your money or need help developing financial goals, contact a financial advisor for personalized guidance.