When you’re comparing savings accounts, CDs, or other financial products, you’ll often see two numbers: an interest rate (or dividend rate, if it’s a credit union account) and an Annual Percentage Yield (APY). At first glance, they might seem like the same thing—but they’re not. Knowing the difference helps you make smarter financial choices, whether you’re opening a savings account or making a long-term investment. Let’s break it down.
Interest Rate or Dividend Rate: the Base Number
Interest Rate
The interest rate is the basic percentage a bank or credit union uses to calculate how much you’ll pay on a loan or earn on a deposit, before considering how often interest is added (compounded).
Let’s say you open a credit union savings account with an interest rate of 3.00%. That’s the base rate your money earns before compounding is applied.
Dividend Rate
At a credit union, the term “dividend rate” is often used instead of “interest rate” for deposit accounts. As a member-owner, you’re technically receiving a share of the credit union’s earnings—similar to a dividend from a company. Functionally, though, the dividend rate works the same way as an interest rate on a bank account.
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Annual Percentage: the Full Picture of Earnings or Costs
Annual Percentage Yield (APY)
APY shows how much you earn in a year on deposits, including the effects of compounding. Compounding is the process of earning interest on your interest (for deposits) or being charged interest on interest (for loans).
If your account compounds interest daily or monthly, you’ll earn a bit more than the base rate, because you start earning interest on the interest that’s already been added. That extra boost from compounding is why the APY is slightly higher than the interest/dividend rate.
Compounding Interest: Dividend Rate vs APY
APY provides a clearer picture of the actual annual earnings from savings accounts, money markets, and certificates because it includes compounding. For loans, APR is the more accurate number for comparing costs between offers, because it reflects compounding as well as fees.
- Interest Rate/Dividend Rate: If a savings account offers a 5% interest rate compounded monthly, the nominal rate is 5%. This is the base number for how much your balance will grow before compounding.
- APY: When considering the monthly compounding, the same account will have an APY slightly higher than 5% because the interest earned each month also earns interest in subsequent months.
Comparing Financial Offers Using APY
If you only look at the interest or dividend rate, you might think two products are equal—but differences in compounding or fees can make one clearly better for your wallet.
A savings account with a slightly lower rate but daily compounding could earn you more than one with a higher rate but annual compounding.
Interest Rate vs APY Example
Always use APY when comparing savings products from different institutions. Knowing the difference between the base rate and APY helps you see the full picture, allowing you to make confident choices—whether you’re saving for a big purchase or making long-term investments.
Let’s compare two savings accounts:
| Account | Dividend/
Interest Rate |
Compounding |
APY |
|
A |
3.00% | Annual | 3.00% |
| B | 3.00% | Monthly |
3.04% |
Both accounts have the same base rate, but because Account B compounds monthly, the APY is slightly higher. That’s the effect of compounding.
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