APY vs. Interest Rate: What Is the Difference?

The nominal interest rate is the periodic rate expressed on an annual basis before the effect of compounding within the year is considered. If a bank pays 0.5% interest every month on a savings account, the nominal annual rate is 6%. The bank uses this rate to determine each individual interest payment, but the nominal rate alone does not tell you what your balance will be at year-end if interest is left in the account.

Nominal rates are sometimes called stated rates, advertised rates, or contract rates. They are the foundation of the APY calculation, not the final answer to "how much will I earn?"

APY captures the real annual return on a deposit after accounting for compounding. Compounding means that credited interest stays in the account and itself earns future interest. The more often interest is credited, the more opportunities there are for that interest to earn additional interest, and the higher the APY.

Under Regulation DD (Truth in Savings, 12 CFR Part 1030), financial institutions must disclose APY to allow consumers to compare deposit products on equal terms. When comparing two accounts with different compounding schedules, comparing their APYs — not their nominal rates — gives the accurate picture.

APY = (1 + r / n)^n − 1

Where: r = nominal annual interest rate (expressed as a decimal, e.g. 0.05 for 5%); n = number of compounding periods per year (1 = annual, 4 = quarterly, 12 = monthly, 365 = daily).

For example, a nominal rate of 5% compounded monthly: APY = (1 + 0.05 / 12)^12 − 1 = (1.004167)^12 − 1 ≈ 0.05116 = 5.116%. The account holder earns 5.116% on their balance over the year, not 5.000%.

For any given nominal rate, more frequent compounding produces a higher APY. The table in this guide shows APY values for a hypothetical 5% nominal rate at common compounding frequencies. The differences are small at typical deposit rates but widen as the nominal rate increases.

Daily compounding is the most common schedule for savings accounts and many CDs at U.S. banks. Monthly compounding is also common. Quarterly compounding produces a slightly lower APY than monthly. Annual compounding — where interest is credited only once per year — produces an APY exactly equal to the nominal rate, because there is no within-year compounding to add.

APR (annual percentage rate) and APY are related concepts used on opposite sides of the ledger. APY applies to savings products: it tells you what you earn. APR applies to lending products: it tells you what a loan costs, though it too may not fully capture compounding depending on the loan type.

For deposit accounts, APY is the correct comparison metric. For credit cards, mortgages, and auto loans, APR is the required disclosure. Applying the logic of one metric to the other — for example, comparing a savings account APY to a mortgage APR — does not produce a meaningful comparison because the calculations and the direction of cash flow differ.

A fixed rate remains unchanged for a specified term, regardless of market conditions. CDs typically carry fixed rates. A variable rate can change — often tied to an index such as the federal funds rate. Savings accounts and money-market deposit accounts typically carry variable rates. APY can also be variable: if the underlying nominal rate changes, the APY changes proportionally.

When comparing a fixed-rate CD to a variable-rate savings account, remember that the savings-account APY shown today may not be the APY for the full period you plan to hold the funds.

APY is calculated assuming the nominal rate is constant, the account balance is unchanged, and no fees are charged. In practice, three factors can reduce the effective return below the stated APY: account fees (monthly maintenance fees, minimum-balance fees), partial withdrawals that reduce the balance on which interest is calculated, and CD early-withdrawal penalties.

APY does not automatically include early-withdrawal penalties for CDs. A CD with a high APY but a six-month interest penalty for early withdrawal may produce a lower effective return than a no-penalty CD with a somewhat lower APY, depending on when the funds are actually needed.

Savings accounts and money-market deposit accounts (MMDAs) are deposit products with variable rates that can be changed by the institution at any time. They typically allow withdrawals, though federal regulations historically limited certain types of transfers per cycle. Banks are required to disclose APY for these accounts under Regulation DD.

Certificates of deposit lock funds for a fixed term at a fixed rate. Early withdrawal typically triggers a penalty. Because the rate is fixed and the holding period is defined, the CD is the deposit product for which the APY comparison is most straightforward — provided you hold to maturity and are not subject to a penalty.

APY is not related to deposit insurance. The Federal Deposit Insurance Corporation (FDIC) insures eligible deposit accounts at member banks up to applicable limits per depositor, per institution, per ownership category. The National Credit Union Administration (NCUA) provides similar coverage for credit-union members. Deposit insurance protects the principal and accrued interest of qualifying deposits against institution failure — it does not guarantee a specific APY.

A deposit that earns a higher APY is not necessarily safer than one that earns a lower APY. If comparing products at institutions with different insurance backing, confirm the coverage structure of both accounts.

Use the CD and Savings APY Calculator to enter a nominal rate and compounding frequency, then see the resulting APY, year-by-year interest, and ending balance for your deposit.