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.
What is APY?
APY stands for Annual Percentage Yield. In non-banker-jargon, APY stands for the amount an account pays to you. (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.
To better understand this, let's look at a basic example. Pretend you have a checking account that offers 2% interest. You keep $100 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 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 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).
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.
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
Which accounts have APY v.s. APR?
|Certificate of Deposit (CD)||X|
|Money Market Account||X|
What is a good APY?
We've learned that the higher the APR, the better (assuming you like getting money for doing nothing). Every institution offers determines their own interest rates on their accounts and the range of differences is pretty surprising.
As of this writing, here are some of the checking account interest rates at a sampling of institutions:
Chase - 0.01% to 0.09%
Bank of America - 0.01% to 0.06%
Wells Fargo - 0.01% to 0.05%
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.
Savings accounts typically have a better APY, but not by much. The average APY on savings accounts 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 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).
How APY Is Calculated
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 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.