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Ken Tumin founded the Bank Deals Blog in 2005 and has been passionately covering the best deposit deals ever since. He is frequently referenced by The New York Times, The Wall Street Journal, and other publications as a top expert, but he is first and foremost a fellow deal seeker and member of the wonderful community of savers that frequents DepositAccounts.

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Smaller Differences Between APYs and Interest Rates


One little known consequence of falling interest rates is that the difference between APYs and interest rates is becoming smaller. APY stands for annual percentage yield. The effects of compounding causes APY to be larger than the interest rate. It assumes that the interest that you earn from an account is put back into the account. This allows you to receive interest on your interest. In our blog post, Understanding Interest Rate and APY, you can see the details of how APY is calculated.

As interest rates go down, the differences between APY and interest rate also goes down. At a certain point, the difference is smaller than one basis point (1/100th of a percentage point). When the difference is this small, interest rate and APY will look the same if rates are listed with two decimal places.

The following example shows how the difference shrinks as the rate falls. This example uses daily compounding.

  • 5.00% rate, 5.1267% APY
  • 3.00% rate, 3.0453% APY
  • 1.00% rate, 1.0050% APY
  • 0.99% rate, 0.9949% APY

As rates fall below 1.00%, APYs and interest rates look the same if the rates are listed with an accuracy of two decimal places.

So for interest rates under 1.00%, there's not really a need to mention the APY. Hopefully, we'll see rising interest rates at some point, and APYs will once again be significantly higher than the interest rates.

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ichaelm   |     |   Comment #1
I'd like to add that, regardless of the interest rate,  the more frequently that the interest is compounded, the greater the difference between the interest rate and the APY.
KenBDG   |     |   Comment #2
ichaelm, that's a good point. Thanks for mentioning that.

I was going to list how the interest rate and APY varies based on compounding. I ended up shortening the example that I included. Here's how the APY from a 5% rate varies based on compounding:

5.00% rate

5.09% APY (compounded quarterly)

5.12% APY (compounded monthly)

5.13% APY (compounded daily)

Anonymous   |     |   Comment #3
It was law at one point ( I thought federal law) that when quoting CD information the APY had to be mentioned or posted first and the rate after that. Also I am going through some files looking for some information on benefits for part-time workers. At one point in time in the 80's (with one of the tax law revisions) someone who worked 20 hours a week was guaranteed 1/2 the benefits that full time people were offered. I am not sure what happened to that law. I know it was still law in  the late 90's. I am looking for that  article. It was written in the Journal of Accountancy. 
Anonymous   |     |   Comment #4
I also remember it being a Federal Law that interest rates were required to be stated in APY.  But since 2008 the banks have been allowed to do whatever they want.

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