By Danielle Smyth Updated September 17, 2020
When it comes to finance, some terms may seem interchangeable, but it’s important to understand the differences between very similar concepts. In most cases, when looking at investments, one evaluates the percentage of their initial investment that they might earn back over a period of time, and how that compares to other uses of this money. Interest rates and yield are similar concepts, but exist on opposite sides of the investment spectrum. Understanding the difference between yield and interest rate is essential for businesses.
Yield vs. Interest Rate
Interest rates are the fees charged, as a percentage of the magnitude, from a lender for a loan. As explained by Fidelity, when loaning money, an institution charges interest, since the value of money today is different than the value of money in five years; the percentage they choose to represent this changing value is their interest rate. Interest can also control the rate of return on some of the more stable investments, like a CD or a bond; the rate the loaning entity charges can change based on the market.
Yield is the percentage of earnings a person receives for lending money. An interest rate represents money borrowed; yield represents money lent. The investor earns interest and dividends for putting their money into a certain investment, and what they make back upon that investment is the yield. It’s also expressed as a percentage.
So while interest rates and yield are tied to each other, Compass Credit Union explains that the terms apply to two completely different situations. You might wonder, what's the difference between yield and return? Interest rates are relevant when considering taking a loan from a lending entity; yield is relevant when considering doing the actual lending. They are, of course, related; yield for any loan needs to be comparable to a general investment interest rate, because the overall transaction needs to be profitable on both sides.
Sample Interest Rates and Yield
For example: A bank customer takes out a loan of $1,000 to purchase a computer. The bank’s interest rate is 10 percent annually. This means that, after a year, the customer will owe the bank $1,000 + ($1,000 x 10%) = $1,000 + $100 = $1,100. The customer pays this back at the set interest rate.
The initial yield for the bank is the $100 they have obtained with the $1,000 they loaned. However, if this transaction cost them $5 in bookkeeping and $15 in hours worked managing this loan, the actual yield is $100 - $20 = $80.
So the yield and interest rate are related; the yield will at best be equal to the interest rate, providing a return at the same percentage point the borrower is willing to pay. In reality, however, yield percent can be lower than interest rate, because the loaner may incur additional costs in managing the loan.
Making Related Business Decisions
For a business looking at the market to determine options, it’s important to understand the rates and how they interact. If a company feels that it can generate more value by investing money into a higher-yield opportunity, they may do so, but that means the money is tied up in an external investment, rather than acting as a reinvestment into the company.
Likewise, if the company feels like interest rates are low enough, they may decide to borrow money to invest into the company, and take the risk of seeing what sort of yield will emerge from a capital investment.
FAQs
The interest rate is (the amount of interest paid by the borrower) / (the par value of the bond). Yield is (the amount of interest paid by the borrower) / (the current market value of the bond). Interest rates and yields can differ when the market value of a bond diverges from its par value.
What's the difference between interest rate and yield? ›
Yield is the annual net profit that an investor earns on an investment. The interest rate is the percentage charged by a lender for a loan. The yield on new investments in debt of any kind reflects interest rates at the time they are issued.
What is the difference between interest return and yield? ›
The yield is the income the investment returns over time, typically expressed as a percentage, while the return is the amount that was gained or lost on an investment over time, usually expressed as a dollar value.
What is the difference between interest rate and effective annual yield? ›
Both are expressed as percentages. The key difference between APY and interest rate is compound interest. APY includes interest that's earned on the original balance as well as the amount of compound interest earned in one year. Interest rate only accounts for interest earned on the original amount.
What is the difference between percentage rate and yield? ›
Annual percentage yield (APY) refers to how much interest you earn on savings and takes compound interest into account. Annual percentage rate (APR) focuses on how much interest you'll pay for money you've borrowed.
What does rate and yield mean? ›
A bond's coupon rate is the rate of interest it pays annually, while its yield is the rate of return it generates. A bond's coupon rate is expressed as a percentage of its par value. The par value is simply the face value of the bond or the value of the bond as stated by the issuing entity.
What is 5% APY on $1000? ›
To find what the APY is on investments, multiply the annual interest rate by the number of times interest is made in a year and then divide that number by one. For example, $1,000 put into an account with an annual interest rate of 5% would, in theory, earn $50 at the end of the year.
What is a good dividend yield? ›
What Is a Good Dividend Yield? Yields from 2% to 6% are generally considered to be a good dividend yield, but there are plenty of factors to consider when deciding if a stock's yield makes it a good investment. Your own investment goals should also play a big role in deciding what a good dividend yield is for you.
What is a good yield? ›
All in all, though, a good yield is anywhere between 5 and 8%, but you should aim for 7 to 8% or beyond for the best yield on property investment. So when you're wondering what is a good rental yield for your property, aim for somewhere between these numbers.
Does interest rate affect yield? ›
When interest rates rise, prices of existing bonds tend to fall, even though the coupon rates remain constant, and yields go up. Conversely, when interest rates fall, prices of existing bonds tend to rise, their coupon remains constant – and yields go down.
While APR measures the amount of interest you'll be charged when you borrow, APY measures the amount of interest you'll earn when you invest or save. The lower the APR, the less you may have to pay in interest when borrowing. And the higher the APY, the more you may earn in interest when saving.
What is a good APY for a savings account? ›
10 best savings accounts of June 2024
| Account type | Best for: | APY |
|---|
| Newtek Bank High-Yield Savings | Those who want a well-established industry name | 5.25% |
| TAB Bank: TAB Save | Multiple account types with great rates | 5.27% |
| Quontic Bank High-Yield Savings | Easy-to-reach customer service | 4.50% |
| Cloudbank 24/7 High Yield Savings | New savers | 5.24% |
6 more rowsIf bond yields rise, existing bonds lose value. The change in bond values only relates to a bond's price on the open market, meaning if the bond is sold before maturity, the seller will obtain a higher or lower price for the bond compared to its face value, depending on current interest rates.
What is the difference between interest and yield? ›
Comparing Yield and Interest Rate:
Yield represents the total earnings from an investment, including interest. Interest rate is the percentage of the amount borrowed or paid, over a principal amount. Yield typically includes the amount of interest earned.
Does higher yield mean higher price? ›
The credit quality, or the likelihood that a bond's issuer will default, is also considered when determining the appropriate discount rate. 4 The lower the credit quality, the higher the yield and the lower the price.
Is yield to maturity the same as interest rate? ›
Yield to maturity (YTM) is the overall interest rate earned by an investor who buys a bond at the market price and holds it until maturity. Mathematically, it is the discount rate at which the sum of all future cash flows (from coupons and principal repayment) equals the price of the bond.
Why do yields fall when interest rates rise? ›
Most bonds pay a fixed interest rate that becomes more attractive if interest rates fall, driving up demand and the price of the bond. Conversely, if interest rates rise, investors will no longer prefer the lower fixed interest rate paid by a bond, resulting in a decline in its price.
Are treasury yields and interest rates the same? ›
Treasury yield is the effective annual interest rate that the U.S. government pays on one of its debt obligations, expressed as a percentage.
What is a good interest yield? ›
The best high-yield savings account rate from a nationally available institution is 5.55% APY, available from My Banking Direct. That's more than 12 times the FDIC's national average for savings accounts of 0.45% APY and is just one of 15 or more top rates you can find in our daily ranking of the best accounts.
What does 5.00% APY mean? ›
A 5% APY means your money earns 5% interest per year. If you deposited $100 in an account that compounds annually, you'd have $105 at the end of a year. But accounts may compound monthly, weekly, daily or even continuously. The more frequent the compounding periods, the more interest you earn.
