EyeOnWhat it means
A savings account might state a rate paid monthly. Because each month's interest then earns interest of its own, the effective yearly figure is a little higher than the stated rate. AER or APY expresses that effective figure so accounts can be compared like for like.
For example, a 4% rate with interest added monthly gives an effective yearly rate of about 4.07%.
How it works
Rates may be fixed or variable, introductory or ongoing, and may depend on conditions such as limiting withdrawals or paying in each month. The rate paid in real terms also depends on inflation and, in many places, on tax.
Deposit protection schemes in many countries cover savings up to a set limit if a provider fails, which is a separate consideration from the rate.
A simple example
Suppose 10,000 is held at a 4.07% effective yearly rate. After one year interest would be around 407 before tax, if the rate did not change. If the rate fell to 3% part-way through the year, the interest would be lower. This is an illustration, and rates are not guaranteed.
Things worth checking
- Check whether a rate is fixed, variable or a short-term bonus.
- Compare the effective yearly figure, not just the headline rate.
- Look at access: notice periods or withdrawal limits can matter.
- Check how deposit protection applies to you.
How it varies by country
AER is common in the UK and some other countries, APY in the US and elsewhere. Tax treatment and protection schemes vary.