by 
The Curious Bag
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Understanding the difference between banking terms like "interest rate," "APR," and "APY" can be confusing. But having a basic understanding is essential for customers to get the best return on their investments.
What is an interest rate and APR?
When people deposit money into a certificate of deposit (CD), they're ostensibly loaning money to a bank. An interest rate is the monthly effective rate received on borrowed money, expressed as a percentage of the sum borrowed. APR is the interest earned over 12 months, without factoring in compounding interest.
What is APY and compounding interest?
The annual percentage yield (APY) is the actual interest rate you receive on your deposit, and it factors in compounding interest. Some certificates receive monthly or quarterly interest payments. When these payments are added to the principal, rather than paid out, they compound. Simply put, compounding interest is interest paid on interest.
Illustrating the Impact: $25,000 deposit in a 24-month CD, with a 2% APR
To illustrate how this difference impacts savings, review the example below. Note how the compounding frequency effects the APY and ending balance. Compounding Frequency APY Ending Balance Daily 2.040% $26,020.24 Monthly 2.039% $26,019.40 Quarterly 2.035% $26,017.68 Semi-Annual 2.030% $26,015.10 Annual 2.020% $26,010.00
Why it matters
When comparing and researching rates on CDs and other deposit accounts, the customer needs to know which rate is being advertised, and how often the interest compounds. The more often that the interest compounds, the better the APY. Sometimes banks will advertise the higher APY to attract customers.
Fun Fact
It's reported that Albert Einstein called compounding interest the strongest force on Earth.
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