APY: Everything you need to know
APY, APR, CD, MMA... Let's face it, there are a lot of acronyms in banking. With most of us entering the real world with little money management training, it can be easy to get confused as to what all these terms mean. One of the most basic terms that you should understand is APY, as it can make the difference of hundreds of dollars a year. So, let's dig in.
What is APY (Annual Percentage Yield)?
APY stands for Annual Percentage Yield. In non-banker-jargon, APY stands for the amount an account pays to you. (Tip: If you find yourself trying to remember what does APY mean, think APY = amount paid to you). Interest is always paid out as a percentage of your account balance and so APY will always be represented as a percent.
How does APY work?
To better understand this, let's look at a basic example. Pretend you have a checking account that offers a 2% interest rate. You keep $100 of your hard-earned money in this checking account. At the end of the year, you would have $102 in the account. (2% of $100 is $2, which is the amount added to your balance in the form of interest).
Now, interest doesn't usually get paid out just once a year. In fact, most of the time it is paid out on a monthly basis. Unfortunately, you don't receive 2% each month. In order to figure out how much interest you will earn per month, you take the APY and divide it by 12 (because there are 12 months in a year).
Let's look back at our original example and figure out how much interest we will earn in just one month. Our imaginary checking account offers 2% over the course of a year, so to figure out how much it pays a month we need to divide that amount by 12. 2% divided by 12 months is .16%. So, we know the account offers .16% interest rate a month. If we take that .16% and apply it to our balance of $100, we will see that we are earning $0.16 in interest in one month.
The lesson: High APY = Good
What is the difference between APY and APR?
APR stands for annual percentage rate, and it is the amount of money you are charged for access to an account. A common example of an account with APR is a credit card. When you carry a balance on a credit card, you are charged interest on that amount (which is why it is so easy to get into debt with credit cards, but that's a whole other issue).
Imagine you have a credit card that has a 20% APR and you have an outstanding balance of $100. We can use the same math we learned above to figure out how much extra we will owe in APR at the end of the month.
Let's do some simple calculations
20% divided by 12 months lets us know we pay 1.66% in interest a month. If our balance is $100 it means we will incur a charge of $1.66 at the end of the month just for the privilege of having access to the line of credit.
The lesson: High APR = Bad
So, what's the difference between APR and APY? The biggest difference between APR and APY lies in how they relate to your savings or investment growth, or the cost of borrowing. In a nutshell, APY refers to what you can earn in interest while APR refers to what you can owe in interest charges.
Which accounts have APY vs. APR?
Checking accounts, savings accounts, certificates of deposit (CDs), and money market accounts are calculated using APY. Mortgages, auto loans, student loans, personal loans, and credit card loans have APR.
What is a good APY?
We've learned that the higher the APY, the better (assuming you like getting money for doing nothing). Every institution determines its own interest rates on its accounts and the range of differences is pretty surprising. Interest rates vary and financial institutions may review their rates weekly or monthly and make changes based on competitors and nationwide trends.
Checking account interest rates at a sampling of institutions can range from 0.01% to 0.09% even at megabanks, although smaller banks may try to be more competitive t bring in more business. If you remember the math from above, you're probably saying "Wait, I deposit $100 and I make one cent a year in interest?" Yes. One whole cent.
What about savings APY?
A savings account will typically have a better APY, but not by much. The average APY on a savings account at the time of this writing is 0.09%. That $100 will now earn you nine cents in a year.
We're going to get selfish for a minute here, but Kasasa was built to offer accounts that actually help people, and one of the major perks of being a Kasasa account holder is high interest on checking and savings accounts. Just take a second and perform a web search for "Kasasa" and your zip code... see what APY is being offered in your area (on average, it is 34x higher).
Finding the best APY for your savings account
Finding the best spot to store your hard-earned cash can feel a bit like dating. You're looking and looking and looking, and eventually end up just wishing a matchmaker would magically appear to set you up with your #foreverroommate. So, just like looking for the perfect partner, the best high yield savings account for you will depend a lot on your needs and preferences. However, there are a few things we think everyone should look for in a high-yield savings account. You should look for a savings account that...
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Offers a high interest rate
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Charges no fees or the fees can be waived easily
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Comes from a financial institution with good reviews
Pay attention to minimum deposit requirements and monthly service fees (aka the fine print) -- A lot of savings accounts require a minimum opening deposit and a minimum balance in order to incur interest. Another common fee is a monthly maintenance charge (which can sometimes be hidden if you aren't careful). That's why it's best to opt for a fee-free account. (Save that money!)
Be wary of promotional offers (hook, line, and sinker) -- some financial institutions offer a promotional interest rate on their savings accounts. These accounts give you a higher APY for an introductory period, after which the APY falls to the regular rate. We aren't saying you shouldn't grab a good deal when one is presented, but just make sure you are aware of when that rate will drop, and that you are still comfortable with that number.
Go for local and community banks or credit unions (we're biased, but we love local and think you should too). Many local banks and credit unions offer great interest rates. Not to mention they're convenient, offer better rates, tend to have better customer service, and are actively serving the very community you live in, but, we digress...
How APY is calculated
Don't worry — we don't think you should be doing all this money math in your head. That's why internet calculators exist, right? Here is a basic APY calculator to help you look at the differences between accounts. This can be really helpful if you want to see the value difference between interest-bearing accounts over a period of time (like comparing two checking or savings accounts).
You just need to enter what you think your average checking or savings account balance is, the APY the account is offering, and how many months you want to see into the future. One important note, there is a concept called "compounding interest" where you earn interest on your interest -- this calculator does not account for that, so the result is conservative. (Want to learn more about compound interest? We've got a game for you.)