How Does Interest Work On A Savings Account?

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If you have a savings account, you’ll earn interest on your money. Banks use simple or compound interest to determine how much to pay you in interest earnings. Let’s review how interest works on a savings account to maximize the money you keep in yours.

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How Interest Is Calculated On A Savings Account

Your financial institution uses either simple or compound interest to calculate earnings on the funds in your savings account. More on this shortly. 

Why Do Banks Pay Interest On Savings Accounts?

Banks and credit unions value their customers, but it’s not the only reason why they pay interest on savings accounts. Interest payments result from what’s referred to as savings interest, which is earned when your financial institution lends the money you deposit into your account to other borrowers through credit card or loan products. 

Simple vs. Compound Interest

The simple interest formula uses the amount of your original deposit to calculate earnings, even if you deposit more over time. To illustrate, if your Annual Percentage Yield ( APY) is two percent and you start with an opening deposit of $2,000, you’ll earn $40 annually. Here’s how your money will grow over time: 

  • Opening deposit: $2,000 
  • Year 1: $2,040 ($2,000 + $40))
  • Year 2: $2,080 ($2,040 + $40)
  • Year 3: $2,120 ($2,080 + $40)
  • Year 4: $2,200 ($2,120 + $40)

Compounding interest works a bit differently, though. The amount you earn is based on your opening balance and earnings over time. To illustrate, using the same opening deposit, but with added interest earnings of $10 over the first year.

  • Opening deposit: $2,000
  • Year 1: $2,050.20 ($2,010 * 1.02)
  • Year 2: $2,091.20 ($2,050.20 * 1.02)
  • Year 3: $2,133.03 ($2,091.20 * 1.02)
  • Year 4: $2,175.69 ($2,133.03 * 1.02)

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Daily vs. Monthly Compounding

If your bank or credit union uses daily compounding, it will calculate your interest earnings each day. But if compounding is monthly, it’ll only be once a month. 

Average Interest Paid On Savings Accounts

According to Bankrate, the average interest paid on savings accounts is 0.06 percent. But you’ll generally get a higher APY with an online savings account. 

Where To Find High Yield Savings Account

It can be challenging to find high-yield savings accounts that pay generous returns. But with Current, you can earn up to 4 percent APY on your money and upgrade your overall banking experience. 

If you aren’t familiar with Current, it’s a financial technology company that offers innovative banking solutions through Choice Financial Group, Member FDIC. There are three account options available, and you can make your money work even harder for you by placing it into savings pods. You can make your money work even harder for you by placing it into savings pods. You’ll also enjoy generous cashback rewards, faster direct deposit, access to over 40,000 fee-free ATMs nationwide, and so much more. 

Get started with Current today by downloading the mobile app on Google Play or App Store or by visiting their website. It’s simple and only takes two minutes of your time.

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