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Understanding APY and Interest Rates: A Comprehensive Guide
What Is APY?
Annual Percentage Yield (APY) is a crucial term to understand when it comes to savings accounts and other interest-bearing accounts. APY takes into account the interest rate and the effect of compounding interest over a year. For instance, if you deposit $100 in a high-yield savings account with a 5% APY, you will earn $5 over the year.
What Is Interest?
Interest is the cost of borrowing money. When you deposit money in an interest-bearing account, the financial institution pays you interest to use your money. Conversely, you pay interest when you borrow money, such as for a mortgage. Interest can be simple or compound. Simple interest applies only to the principal balance, while compound interest applies to both the principal and any accumulated interest.
APY vs. Interest Rate
While both APY and interest rates are important, they serve different purposes. The interest rate is the cost of borrowing money or the earnings from depositing money. APY, on the other hand, includes the effect of compounding and provides a more accurate picture of your potential earnings over a year.
APY vs. Interest Rate Example
Consider a Certificate of Deposit (CD) with a 5% interest rate and a one-year term. If the interest compounds monthly, the APY will be higher than the interest rate. For example, a $1,000 CD with a 5% interest rate that compounds monthly will have an APY of 5.12%, earning you $51.16 over the year.
Which One Is More Important to Know for Savings Accounts?
While understanding both interest rates and APY is useful, APY is generally the more important number. It takes into account the interest rate and the effect of compounding, providing a clearer picture of your potential earnings. Regulators require banks and credit unions to advertise the APY, making it easier to compare different accounts.
The Bottom Line
No matter what type of compounding your savings account uses, the important thing is that you’re earning money on your savings. Having a clear savings strategy and goals can help you build your savings and reach your financial objectives without taking on additional debt. Whether you’re building an emergency fund or planning a vacation, it’s reassuring to know you have money set aside for when you need it.
Contact O1ne Mortgage for Your Mortgage Needs
At O1ne Mortgage, we understand the importance of making informed financial decisions. Whether you’re looking to buy a new home or refinance your existing mortgage, our team of experts is here to help. Call us today at 213-732-3074 for personalized mortgage services that meet your needs.
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