How to Calculate Interest on a Savings Account – Forbes Advisor
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The free money doesn’t come often, but with a savings account it usually comes once a month. This is because banks pay you interest for keeping money in a savings account. But how much interest can you earn?
Although the answer will vary depending on your financial institution and a few other factors, knowing how to calculate interest on a savings account can help you estimate your earnings where you decide to save your money.
What is interest?
The easiest way to understand interest is to think of it as the cost of borrowing or lending money. You pay interest on a car or mortgage when you borrow. But when you put your money in an interest-bearing savings or money market account, you’re essentially lending your money to the bank.
The bank uses your money and pays you interest. It lends money you’ve “borrowed” from other customers for car loans, personal loans and more.
While that might seem like a lot of lending and borrowing, here’s what you need to remember: When you put money into an interest-bearing account, the bank pays you for doing nothing more than choosing it as your house for your nest egg.
Simple or compound interest
Interest generally comes in two forms: simple and compound. Almost all savings accounts pay compound interest, but knowing how to calculate simple interest can help you estimate your potential earnings.
Simple interest is the amount of interest you would earn based only on your principal balance, which is the total value of the deposits in your account. In a scenario involving simple interest, your deposits would earn interest, but the interest you would earn would never increase.
For example, if you make a one-time deposit of $10,000 into a savings account that earns a simple interest rate of 2.00% per year, you will earn a fixed amount of $200 each year, your $10,000 remaining on the account. You will earn no interest on the $200 you earn each year. So after 10 years your balance would be $12,000.
Balances that earn compound interest have the potential to grow faster than funds that earn simple interest. That’s why Albert Einstein once called compound interest the “eighth wonder of the world.”
Compound interest is the interest paid on your principal balance and any interest you have already accrued. In other words, the principal in your account earns interest, as does the interest itself.
Banks pay interest based on the capitalization period of an account. A compounding period is simply how often the bank calculates how much interest it owes you. Savings account interest is usually compounded daily or monthly and credited to your account monthly.
Using the same values as in the example above, a $10,000 deposit earning 2.00% compound interest would generate $2,214 in interest over 10 years, for a total of $12,214. That’s a difference of $214 in your favor made possible by the power of compound interest.
How to Calculate Interest Earned on a Savings Account
You can use an online savings interest calculator to help you determine how much interest you will earn. If you prefer the satisfaction of DIY math, use this formula to calculate simple interest on a savings account:
P x R x N = Interest earned
P is the principal, or your opening balance
R is the interest rate (APY, expressed as a decimal)
NOT is the number of periods (usually expressed in years)
Suppose you put $10,000 in an APY savings account at 1.50% for one year:
$10,000 x 0.015 x 1 = $150 interest earned for the year
The compound interest formula is more like a spinning head:
[P (1 + R)^N] – P = Interest earned
Doing these calculations by hand can be tricky, so you’ll probably want to stick with the calculator.
How much interest you can earn based on your balance
How much “free money” can you earn each year just by storing your money in savings? Here’s a handy chart you can use as a guideline, with some sample interest rates.
Note: The calculations below assume a one-time deposit with no additional deposits for a one-year term. The interest rates shown are for demonstration purposes only.
Ways to Earn More Interest
If you’re looking to earn the highest possible interest rate on your savings, here are some tips that might help you earn more:
- Look beyond your current bank. Online savings accounts are FDIC insured, just like a savings account at any traditional bank, and they often offer significantly higher returns than physical banks.
- Consider a money market account. Depending on the bank, money market accounts can offer higher returns than regular savings accounts if you can meet minimum deposit requirements.
- Discover high-yield savings accounts. Although not all banks offer one, a high-yield savings account could quickly increase your interest income.
- Ask about rate increase opportunities. Look for banks that offer higher interest rates on their savings accounts when you reach certain savings milestones, such as maintaining a balance of $1,000 or more.
- Make regular deposits. Constantly adding to your savings account will steadily increase the interest you earn over time.
Now you know how to calculate interest on a savings account and how compound interest helps your savings balance grow over time. Feel free to shop around and compare multiple banks to ensure you receive the best possible rate based on your opening deposit. Since a bank is going to pay you to save money, you might as well make sure that you maximize your payment.
Find the best high yield savings accounts of July 2022
Frequently Asked Questions (FAQ)
Is my money safe in an online savings account?
Yes. Online savings accounts are FDIC insured against bank defaults up to $250,000 per depositor per bank.
What’s the point of saving when APYs are lower than the rate of inflation?
Even when interest rates are low and inflation is high, having money in savings can protect you in an emergency. Having cash on hand to pay for unexpected expenses saves you from having to use your credit cards or dip into your retirement savings.
Why do online savings account interest rates tend to be higher than in physical banks?
Air. When a bank has to pay for branches, tellers, and other expenses associated with having physical locations, it translates to less money available to pay customers in interest.