Interest on a Savings Account: How Your Money Can Make Money

Understanding how savings account interest works can help you reach your financial goals more effectively. It may seem like free money, but by grasping how interest is calculated, you can maximize your savings.

Interest is typically seen as a charge for borrowing money. When you take out a loan or use credit, the bank sets an interest rate based on the broader interest rate environment and specific factors related to the bank. However, with a savings account, the roles are reversed: the bank borrows your money and pays you interest for the privilege.

Although interest on a savings account may not be the quickest way to build wealth, it offers stability since your deposited amount is not subject to market risk. Your balance will grow steadily without any effort on your part.

Simple vs. Compound Interest

Simple Interest: This is the interest earned on the initial amount deposited in your savings account each month.
Compound Interest: This is the interest earned on both the initial deposit and the interest accrued monthly, essentially earning interest on interest.

Calculating Interest on a Savings Account

Simple interest is calculated using the determined interest rate and the timeframe in which the interest is paid, usually monthly. Larger account balances and longer periods of time in the account will yield more interest.

APY vs. Interest Rate

Annual Percentage Yield (APY): This is the amount of interest you would earn over a year, including compound interest.
Interest Rate: This is the stated rate paid by the bank, not accounting for compounding.

Different banks offer varying APY rates for different types of accounts. Some banks even offer higher interest rates for larger deposits. When choosing a bank, compare the APYs of multiple banks and consider the savings solutions each offers. Higher APY percentages mean more interest earned and faster growth for your money.

Interest Rate Fluctuations

Interest rates can fluctuate in response to changes in the Federal Reserve’s rates. As a result, the interest earned on your savings account may vary. Typically, when the federal rate increases, banks follow suit, and when it decreases, banks adjust their rates accordingly.

How Banks Pay Interest on Savings Accounts

Banks deposit savings account interest payments directly into the account, helping you reach financial goals like saving for a new home or building an emergency fund. However, APYs aren’t the only consideration. You should also look at fees, withdrawal limitations, digital capabilities, and money transfer options. Fees, in particular, can negate the interest earned, so consider all factors.

In conclusion, while compound interest in a savings account can be a great way to achieve short-term financial goals, it’s essential to evaluate all aspects of the account to ensure it meets your needs.

The USAA Advice Center provides general advice, tools, and resources to guide your financial journey. This content is for informational purposes only and does not constitute an endorsement by USAA or its affiliates. All information is subject to change without notice.