Expert: Gina Boykin - 10/26/2007

Question
I was thinking of investing in a CD, but I'm confused as to the difference between the APY and the interest rate. The 2 figures are close, but not the same. I don't understand.

Answer
The interest rate is the rate that the bank uses to calculate interest each period (day, week, month, year).  The APY tells you what you will actually get paid in interest over a 1-year period.  Let's see an example:

If you deposit $1,000 in a CD that pays 6 percent interest monthly, then the first month you will receive ($1,000 x 6 percent/12)=$5.00.

The 2nd month, you will receive interest on $1,005 (your initial deposit   accumulated interest), or $5.03.

By the end of the year, you will have received $61.68 which is 6.17 percent of your deposit.  This is your APY, vs. the 6 percent rate that is quoted.

What you can see is that APY is really the percentage that matters, and that the more your interest compounds, the better off you are.  Daily is better than monthly, monthly better than quarterly, etc.

Hope this helps!