When people open a savings account, they are usually looking for a safe place to store their hard-earned money. When people open a checking account, they likely open it so that they can be paid by their employer via direct deposit and/or to help them more easily pay for things. These are just a couple of the great benefits to having a deposit account (savings or checking account) at your bank. But did you also know that most banks will pay you for holding certain deposit accounts with them? This payment is called interest, and this article explains what it is and how it works.
In this case, interest is referred to as the percentage of your account balance that a bank will pay you for keeping your money on deposit with them. It can be paid daily, monthly, or quarterly and is expressed as an Annual Percentage Yield (APY). It’s important to note that the interest rate on savings and checking accounts is often variable and can change over time.
When you deposit money at a bank, that bank can use those funds to loan money to borrowers who then pay interest on their loans. (Don’t worry – your money is still your money, and you can still access it when you need it.) Banks pay interest on some deposit accounts to help retain current depositors and their balances as well as to attract new depositors. This is ultimately how banks make money because the difference between the interest earned from loan borrowers and interest paid to depositors (plus other operating expenses) is considered the bank’s profit.
It varies from bank to bank. However, most banks will pay interest on some deposit accounts but not all of them. When searching for a new deposit account that pays interest, be sure to double check the account agreement to see if interest is paid on that account.
Interest can be calculated using a simple interest formula: P X R X N
P = Principal Amount (beginning balance)
R = APY (expressed as a decimal)
N = Number of time periods
If you put $1,000 in your account and keep it in there for the entire year, with a 1.00% APY, you will earn $10 in interest:
1,000 X .01 X 1 = $10
However, for many accounts, especially checking accounts, funds are deposited and withdrawn throughout the year. In that case, the average account balance throughout the year would be used to calculate interest.
The beautiful thing about interest-paying accounts is that you can earn interest on interest over time. This is called compounding interest. Using the first example above, if you leave the $10 you earned in interest in your account, you will have a total of $1,010 which will then earn another 1.00% APY over the next year, or $10.10.
Calculating compound interest can be a bit tricky. Fortunately, there are calculators available that make it simple and easy. All you need to know is your principal amount, how much you plan to deposit in additional funds, your timeline (in months or years) and your APY.
If you have questions about interest rates or any of your banking needs, a Personal Banker from FNBO would be happy to answer them. Give us a call today or chat with a Personal Banker by downloading the Twig by FNBO app.
The articles in this blog are for informational purposes only and not intended to provide specific advice or recommendations. When making decisions about your financial situation, consult a financial professional for advice. Articles are not regularly updated, and information may become outdated.