Plain-language meaning
APY shows the effective annual return after compounding. It is useful when interest is credited more than once per year, because the interest earned earlier can start earning interest too.
Formula idea
APY = (1 + r/n)^n - 1, where r is the nominal annual rate and n is the number of compounding periods per year.
Example
A 5% nominal annual rate compounded monthly has an APY of about 5.12%. The difference is small over one year, but it becomes more important when comparing savings accounts, certificates or investment assumptions.
APY vs APR
APY is usually used for earned interest and includes compounding. APR is often used for borrowing costs and may not reflect the same compounding treatment. Compare products using the same measure whenever possible.
What to check
- Check whether the rate shown is nominal, APR, APY or another effective rate.
- Confirm the compounding frequency before comparing two offers.
- Remember that fees, taxes and early-withdrawal penalties can reduce real returns.
FAQ
Is a higher APY always better?
For the same risk, fees and access terms, a higher APY is better. But restrictions, penalties or risk can make a higher headline rate less attractive.
Can APY be used for loans?
It can describe an effective annual rate, but loan offers usually use APR or country-specific disclosure rules.