Free money doesn’t come along often, but with a savings account, it typically arrives once a month. That’s because banks pay you interest for keeping money in a savings account. But how much interest can you earn?
While the answer varies 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 wherever you decide to save your money.
What Is Interest?
The easiest way to understand interest is to consider it as the cost of borrowing or lending money. You pay interest on an auto loan or mortgage when you borrow. But when you put your money into 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 the money “borrowed” from you to other customers for auto loans, personal loans and more.
While that can sound like a whole lot of lending and borrowing, here’s what you need to remember: When you put money in an interest-bearing account, the bank pays you for doing nothing more than choosing it as a home for your nest egg.
Simple vs. Compound Interest
Interest typically comes in two forms: simple and compound. Nearly 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’d earn based solely on your principal balance—that’s the total value of the deposits in your account. In a scenario involving simple interest, your deposits would earn interest, but the interest you’d earn would never grow.
For example, if you made a one-time deposit of $10,000 into a savings account that paid a simple interest rate of 2.00% annually, you would earn a flat $200 each year your $10,000 remains in the account. You wouldn’t earn any interest on the $200 you collected 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 earning simple interest. That’s why Albert Einstein once declared compound interest the “eighth wonder of the world.”
Compound interest is interest paid on your principal balance and any interest you’ve previously accumulated. In other words, your account principal earns interest—and so does the interest itself.
Banks pay interest based on an account’s compounding period. A compounding period is simply how frequently the bank calculates how much interest it owes you. Savings account interest is typically compounded daily or monthly and credited to your account monthly.
Using the same values from the example above, a $10,000 deposit earning 2.00% interest that’s compounded would accrue $2,214 in interest over 10 years, for a total of $12,214. That’s a $214 difference—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’ll 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 principal, or your beginning balance
R is interest rate (APY, expressed as a decimal)
N is the number of time periods (usually expressed in years)
Say you place $10,000 in a 1.50% APY savings account for one year:
$10,000 x 0.015 x 1 = $150 interest earned for the year
The formula for compound interest looks like more of a head spinner:
[P (1 + R)^N] – P = Interest Earned
Doing that math by hand can be tricky, so you’ll probably want to stick to the calculator.
How Much Interest You Can Earn Based on Your Balance
How much “free money” can you earn each year just by stashing your cash in savings? Here’s a handy chart you can use as a guideline, featuring a few sample interest rates.
Note: Calculations below assume a one-time deposit with no additional deposits throughout a one-year term. Interest rates shown are for demonstration purposes only.
Interest Earned Per Year – Compounded Monthly
|0.10% APY||0.50% APY||1.50% APY|
Ways to Earn More Interest
If you’re looking to earn the highest possible interest rate on your savings, here are some tips that could 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 yields significantly higher than brick-and-mortar banks.
- Consider a money market account. Depending on the bank, money market accounts can offer higher yields than regular savings accounts if you can meet the minimum deposit requirements.
- Explore high-yield savings accounts. While not every bank offers one, a high-yield savings account could rapidly increase your interest earnings.
- Ask about rate bump opportunities. Look for the best 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. Consistently 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 along with how compound interest helps your savings balance grow over time. Don’t be shy about shopping around and comparing multiple banks to make sure you receive the best rate possible based on your opening deposit. Since a bank is going to pay you to save money, you might as well make sure you’re maximizing your payout.