When you put money into a savings account, your bank doesn’t just hold it for you it pays you for keeping your money there. That payment is called interest earned on savings. In simple terms, interest is extra money your bank adds to your account over time as a reward for saving.
Understanding how savings interest works helps you compare accounts, choose better banks, and grow your money faster even if you’re just starting out.
How Savings Accounts Earn Interest
When you deposit money into a savings account, the bank uses part of that money to fund loans for other customers, like mortgages or car loans. The bank charges borrowers interest and shares a small portion of that interest with you.
This isn’t something shady it’s how the banking system keeps money moving through the economy. The bank still makes a profit because it charges borrowers more interest than it pays savers.
The Two Types of Savings Interest
There are two main ways banks calculate interest on savings accounts:
1. Simple Interest
Simple interest is calculated only on the money you originally deposit.
Example:
If you deposit $100 into a savings account that pays 5% interest once per year, you earn:
-
$100 × 5% = $5 in interest
-
Total after one year: $105
This method is easy to understand but less powerful over time.
2. Compound Interest
Compound interest is more common and more rewarding. It means you earn interest not only on your original deposit, but also on the interest you’ve already earned.
Example:
You deposit $100 at 5% interest, and the bank adds interest monthly.
After one year, your balance becomes $105.12, not just $105. That extra $0.12 comes from earning interest on interest.
It may not sound like much, but over years especially with regular deposits it adds up fast.
What Information You Need to Calculate Savings Interest
To estimate how much interest you’ll earn, you’ll need:
-
Starting balance (principal): How much money you deposit
-
Interest rate: The percentage your bank pays
-
How often interest is added: Daily, monthly, or yearly
-
Time period: How long your money stays in the account
Once you have these details, you can calculate interest manually or use online tools.
Saving Regularly: The Real-Life Scenario
Most people don’t make one big deposit and walk away. Instead, they add money regularly like $100 every month.
Example:
You start with $0 and deposit $100 each month into a savings account earning 5% interest, compounded monthly, for five years.
At the end of five years:
-
Total deposits: $6,000
-
Final balance: about $6,800
That extra $800 is interest you earned simply by being consistent and patient.
Using Spreadsheets to Calculate Savings Growth
If you like numbers or want quick answers spreadsheets like Excel or Google Sheets make this easy. They have a built-in future value (FV) function that calculates how much your savings will grow over time.
You can adjust:
-
Interest rate
-
Time period
-
Monthly deposits
This is especially useful when comparing different savings accounts or planning long-term goals.
Understanding APY (Annual Percentage Yield)
Banks usually advertise savings accounts using APY, not just an interest rate.
APY shows:
-
The total amount you’ll earn in one year
-
Including the effect of compounding
That’s why APY is often higher than the stated interest rate.
Example:
An account with a 5% interest rate compounded monthly has an APY of about 5.12%.
APY makes it easier to compare accounts because it reflects real earnings over a year no math required.
Common Questions About Savings Interest
How much interest will $1,000 earn in a savings account?
If your account has a 0.01% APY, you’ll earn about $0.10 in one year. That’s why many savers look for high-yield savings accounts.
When is savings interest paid?
Most banks calculate interest daily and pay it monthly, but this can vary. Always check your account details.
How do banks calculate monthly interest?
Banks typically divide the annual interest rate by 12 and apply it to your balance each month, often using daily balances.
Why Understanding Savings Interest Matters
Even small differences in interest rates can mean hundreds or thousands of dollars over time. Knowing how interest works helps you:
-
Choose better savings accounts
-
Set realistic financial goals
-
Make your money work harder with less effort
Saving isn’t just about discipline it’s about using the right tools. And interest is one of the simplest tools you’ve got.
