APR vs. APY

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For example, let’s say you deposit $10,000 into an account that has an APR of 5%. If interest is only applied once per year, you would earn $500 in interest after one year.

On the other hand, let’s say that interest is applied to the balance monthly. This means that the 5% APR will be broken down into twelve smaller interest payments for each month, or in this case around 0.42% per month. Using this method, your $10,000 deposit will actually earn $42 in interest after the first month. That means in the second month, 0.42% will be applied to the new balance of $10,042, and so on.

In this example, even though the APR is 5%, if interest is compounded once a month, you would actually see almost $512 of earned interest after one year. That means the APY turns out to be around 5.12%, which is the actual amount of interest you’ll earn if you hold the investment for one year.

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