What is APY (Annual Percentage Yield)?
Annual Percentage Yield (APY) Definition
Compounding interest on smaller time frames increases the annual interest rate.
For example, an investment compounded monthly with a 12% APR will have a 12.68% APY.
The formula for computing the Annual Percentage Yield is:
APY = 1 plus r divided by n to the power of n, minus 1, where “r”is the stated annual interest rate and “n”is the number of compounding periods each year.
The smaller the time frame interest compounds, the higher the APY will be.
How Does APY Work?
Interest earned and interest borrowed are calculated the same way, but stated differently whether it is stated from the perspective of an investor or creditor.
APY is the same as the Effective Annual Rate, or EAR, but APY is stated from the investor’s perspective.
The EAR computes the actual interest paid to a creditor after factoring all fees and interest compounding on smaller time frames.
Nominal Interest Rate, APR and APY
Here is how to remember nominal interest rate, APR, and APY:
- Interest rate is the interest on the principal borrowed (or earned) which does not factor in additional fees, usually stated annually.
- Annual Percentage Rate (APR) is the interest plus additional fees, stated as a percentage. APR does not factor in rates compounded on smaller time frames.
- Annual Percentage Rate (APY) factors in additional fees and whether the rate is compounded on a smaller time frame.