How to calculate interest in a savings account

Quick insights

• Interest is the amount of money a bank pays you for keeping your money in a savings account.
• Interest can be calculated using a simple interest or compound interest formula.
• Savings accounts may have higher interest rates than checking accounts.

While keeping cash at home might seem convenient, the interest earned by a savings account may offer an advantage by allowing your money to grow over time.

In this article, we’ll talk about different kinds of interest and how to calculate interest on a savings account.

Understanding the basics of interest in savings accounts

Interest is the money you earn from keeping funds in a savings account at a bank. Think of it as a bank's payment to the account holder for depositing and keeping their money in the bank. While most savings accounts earn interest, rates can vary. Any interest earned is typically automatically deposited into your account by the bank on a monthly basis.

The rate your account earns interest can vary depending on the bank and the type of account. For example, a traditional savings account may have a higher interest rate than a checking account.

When you open a savings account, your rate will be listed as an annual percentage yield (APY). APY is the rate at which the money in your savings account will earn interest. The rate is not fixed and can change over time due to federal interest rates and market fluctuations.

Types of savings accounts interest rates

There are two main types of interest rates that can be applied to savings accounts—simple interest and compound interest. Knowing how to calculate these rates may help you determine how much interest you can earn.

Here’s how they differ:

Simple interest

Simple interest is calculated based on the principal amount in your account. It’s helpful when determining how much an initial deposit will earn over a given period of time. If you put money into a savings account, simple interest will tell you how much you’ll earn on that initial deposit over time.

Compound interest

Compound interest is slightly more complicated because it factors in more than the initial deposit. Compound interest calculates the principal plus any earned interest over time. So, if you put an initial deposit into a savings account, compound interest will calculate what you earn on the initial deposit plus any interest you earn in addition to the deposit. In other words, your interest can earn interest.

How to calculate interest in a savings account

To calculate interest on your savings account, there are two formulas you can use—one for simple interest and another for compound interest. Let’s break them down with examples and calculations.

Guide to calculating simple interest

There are three components to the simple interest formula:

• Principal (P): The initial deposit amount
• Rate (R): The interest rate (in decimals)
• Time (T): The amount of time your deposit will accrue interest

When put together, the formula is:

Principal x Rate x Time = Interest

Here’s how you would calculate that.

Let’s say you have an initial deposit of $1,000. It earns an annual interest rate of 5%. You want to calculate the interest over a 3-year period.

You calculation would be: $1,000 x .05 x 3 = $150

If your rate remains unchanged, you’d earn $150 in interest on your initial deposit after 3 years.

Guide to calculating compound interest

Calculating compound interest is more complicated because it factors in the money you earn on interest as a part of the equation. The formula for calculating compound interest is

P(1 + r/n)^(nt) = A

Let’s define each variable in this equation to make it a little clearer:

• P = Principal amount (the $1,000 deposit)
• r = Annual interest rate (5% equals 0.05)
• n = Number of times interest is applied per time period (e.g., 1 year of interest compounded monthly equals 12 and 3 years compounded monthly equals 36)
• t = Number of time periods the money is invested (in this example, it would be 36 months)
• A = Total amount of money accumulated (your deposit plus interest you’ve earned)

Let’s use the same numbers we used for the simple interest calculation above, but using the compound interest formula. We are compounding interest monthly on $1,000 over 3 years at a 5% rate.

$1,000(1 + .05 / 12)^(36) = $1,161.47

Comparing the amount earned in simple interest—$150—to the amount earned in compound interest—$161.47—illustrates that compound interest can result in more earnings over time.

Online compound interest calculators are available to assist with the calculations.

How savings accounts and interest work together

Keeping your money in a savings account generally allows it to earn interest. The amount of interest depends on a variety of factors, including:

• The initial deposit
• How much you deposit over time
• The APY

Higher interest rates generally lead to more interest earned. The more interest you earn, the more your money can grow through compound interest. Larger deposits may also contribute to increased earnings.

Choosing the right savings account for earning interest

When choosing a savings account, you may want to consider the bank’s:

• Interest rate: What is the account’s current APY?
• Compounding frequency: Is interest compounded daily, monthly, quarterly or annually?
• Minimum balance requirements: Do you need to keep a minimum amount of money in your savings account, and if you can’t, what happens?
• Fees: Does the account charge monthly maintenance or low balance fees?
• Number of withdrawals: Is there a maximum number of withdrawals you can make in a month and if so, what happens if you exceed that number?

High-yield savings account

A high-yield savings account may offer a higher rate of return than a traditional savings account. The APY on these accounts is often several times higher than those offered by savings accounts at traditional brick-and-mortar banks. Typically, high-yield savings accounts are offered by online banks, which can provide higher APYs due to lower overhead cost.

In summary

Your account’s terms and conditions should explain how interest is calculated and applied to your account. Knowing this can help you determine how much interest you can potentially earn on your savings account.