On one of my savings accounts it says 5.07% interest rate with a 5.20% APY, that’s a 0.13% spread.
On another account they offer for example, a CD, it says 4.22% interest rate with a 4.30% APY, that’s a 0.08% spread.
The interest rates are pretty close, so why is the spread between the rate and APY so much different?
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It isnt a “spread”. The APY is how much your balance will go up after 1 year - at 5.2% APY, $1,000 will be $1052.00 1 year later. But that $1k will only earn 5.07% each day (totalling $1050.70), you end up with more after a year because of compounding - day 1 your $1k will earn $.14. Day 2 your $1k will earn another $.14 but day 1’s $.14 will also earn $0.00002. Day 3 will earn another $.14 plus your $.28002 earnings will earn another $.00004. Etc etc. The interest rate is constant, but is being applied to a slightly larger balance each day.
The difference between interest rate and APY depends on how often interest is compounded. If compounded daily the “spread” will be larger, if compounded annually there will be no “spread”.
I know about compounding but didn’t understand why the 5.07% rate compounds to 5.20% but the 4.22% only compounds to 4.30%. A much lesser amount for similar rates.
(1+5.07%/12)^12 = 1.052
(1+4.22%/12)^12 = 1.043
Lesser rates compound less because they are lesser.