APY stands for annual percentage yield, which shows how much interest you can expect to earn (or be charged if you are borrowing money) after the effects of interest compounding are included. Interest compounding occurs when interest is added to the account more than once per year and then begins to earn additional interest. For example, if you had $1,000 in a savings account and interest was compounded monthly, at the end of the first month $1 in interest would be added.
For the next 11 months of that year, that additional dollar is earning interest as well. To convert from an APY to an annual interest rate, you also need to know how many times per year interest is compounded. This information should be readily available from the bank or financial organization you are collaborating with. These important data points will allow you to quickly and easily begin understanding the detailed relationship between your APY and your interest rate.
Convert to a Decimal
Convert the APY to a decimal by dividing by 100. For example, if your APY was 5.5 percent, you would get 0.055. It is critical that you double check your results in this first step, as the remainder of the process relies on the accuracy of this initial calculation.
Add 1 to the Decimal
Add one to the APY expressed as a decimal. For example, 0.055 plus 1 equals 1.055.
Calculate Number of Interest Payments
Raise the result from step 2 to the 1/Nth power, where N equals the number of times per year interest is compounded. For example, if your account compounds interest monthly, you would raise 1.055 to the 1/12 power and get 1.004471699.
Subtract 1 from the result in step 3. For example, you would subtract 1 from 1.004471699 to get 0.004471699.
Multiply the Compounded Interest Amount
Multiply the result from step 4 by the number of times per year the interest is compounded. For example, since interest is compounded monthly you would multiply 0.004471699 by 12 and get 0.053660387.
Multiply by 100
Multiply the result from step 5 by 100 to convert to a percentage to find the interest rate. For example, you would multiply 0.053660387 by 100 to find the interest rate equals about 5.366 percent if the APY is 5.5 percent and interest is compounded monthly. With this information on hand, you can begin to plan smart financial strategies which guarantee that both your short and long term goals remain possible.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."