How to Calculate Interest Earned on a Savings Account
Banks pay you money, known as interest, for your cash deposit in their savings accounts. That money is not a random figure; it was determined based on some factors, which include your savings account balance at a particular time. While this is usually an automatic process, you can estimate the amount you will earn in your savings account if you know how to calculate interest rates.
But why should you care to have this knowledge? It will enable you to differentiate high-yield savings accounts from low-yield alternatives so that you can make the most rewarding choice. Read on for more information.
How Simple Interest Differs from Compound Interest
As you may have already realised, simple interest is not the same as compound interest. We explain their differences below.
What is Simple Interest
Simple interest is the amount of interest you would receive based only on the main balance of your account, which is the value of the total deposits you have made. Here, the interest on your deposit never increases throughout the accounting period. It works just like we explained in the example we made above.
What is Compound Interest
Unlike simple interest, compound interest allows you to earn new interest on your previous interest over time, thereby increasing your total earnings. This method is known as "compounding." Keep in mind that the interest rate on a savings account is often presented as an annual percentage yield (APY).
Compound interest is a process that helps your savings account balance grow faster than simple interest. It is not only paid on your previous balance but also on every amount of interest you accumulated in the previous month or accounting period. For example, if interest is compounded monthly and you open a high-yield saving account with a 12% APY, it means that your interest will be calculated at 1% monthly along with your increasing balance until the end of the accounting year.
Compound Interest Formula
The formula for calculating compound interest is:
A=P(1+r/n)nt
Where
A = Amount or ending amount.
P = Principal or beginning balance.
r = Interest rate (decimal).
t = Time.
n = Number of times interest is compounded per given time “t”
Now, using the previous example, if your savings account balance is €50,000 and the interest compounds monthly for 1 year at 10% APY, when you put these figures in the formula above and solve the equation manually or by means of a calculator, you will have:
A=50000(1+0.10/12)12x1 = €55,235.65, which will be the ending amount.
So, the total interest earned will be €5,235.65. Compare this to what we got using the simple interest approach, and you will see an additional €235.65 earned on the same initial deposit.
No doubt, compound interest is an excellent way to make your money work for you. Besides, adding the extra step of making consistent deposits into your savings account can truly help your money grow. You will see your account balance increase faster with additional deposits than just interest.
Savings Account: Meaning and Key Features
A savings account is one of the most common products offered by traditional banks and neobanks. It makes it easy for people to not only make deposits and withdrawals but also grow their money through interest. A savings account is not the same as a checking account. You can find the differences between them in this post.
The features of a savings account vary across different banks. Nonetheless, one of the key features of a savings account is the ability to reward the owner of the deposit by adding a small amount to the balance over time. This is known as interest earning.
Another notable feature of a savings account is being able to transfer money online using a web-based platform or mobile app, which is usually provided by the bank or financial institution that registered the account. Depending on several factors that slow down money transfers and the expertise of the account provider, you will find that some savings accounts make faster transfers than others.
How to Calculate Simple Interest on a Savings Account
The right way to calculate the simple interest on a savings account is to multiply the principal amount (which is the account balance) by the interest rate (expressed as a percentage or fraction) and by the period (time) of the savings. In other words, simple interest is calculated using the following formula:
Simple Interest (SI) = P x R x T.
Where
P = the principal amount or beginning balance
R = Interest rate (r/100)
T = Time period of the savings (usually, 1 year)
For example, let’s assume that you opened a savings account with a newly launched challenger bank called AW Bank and deposited €50,000 in it. If the interest rate is 10% per year, which is 0.10, your simple interest will be:
SI = 50,000 x 0.10 x 1 = 5000.
Therefore, your interest will be €5,000.
When this amount is added to your principal, your new balance in your savings account at AW Bank will be €55,000.
Based on the example above, you can see how much more money you will have made in a year just from keeping a deposit under such terms. However, this is not often the exact case in reality. That is because banks do not normally use simple interest for savings accounts. They often use compound interest!
How to Account for Ongoing Savings with Deposits
In contrast to the example that we have given above, in which we assume that a single deposit is made, most individuals do not save in that way. What is rather common is that they deposit money into a savings account on a regular basis. So, how can you calculate the final amount from ongoing savings with a series of deposits? You can do it by making a little change to the formula for calculating compound interest. Here, you need to estimate the future value of the principal using the formula below:
FV = Pmt x [{(1+r)n – 1} /r]
Where
FV = future value of your deposits with compounding interest.
Pmt = Payment amount per month.
r = Rate of interest per month (that is, annual rate divided by 12).
n = Number of months.
Savings Account APY: How to Calculate Annual Percentage Yield
As the calculation shows, monthly compounding raises your yearly returns. Typically, you'll receive an interest rate expressed as the annual percentage return when you create a savings account (APY). Since this figure is typically greater than the "interest rate" and takes compounding into account, most banks promote APY for interest-bearing accounts. However, because it does not account for ongoing contributions, its optimum application is for calculating the value of a single deposit at the end of an accounting year, which is any period of 12 months.
The formula for calculating APY is:
APY = {1 + (r/n)}n – 1
Where “r” and “n” are the annual interest rate and the number of compounding periods (months) per year, respectively.
Therefore, assuming that the annual interest rate on a savings account is 5% (which is 0.05), the APY can be calculated as follows:
APY = {1 + (0.05/12)}12 – 1
= (1 + 0.004167)12 – 1
= 1.0512 – 1 = 0.0512
Therefore, the APY is 5.12%. You can see that it is higher than the annual interest rate. For that reason, banks pay you more when they use the APY. And when you want to calculate your earnings on your savings, you use the value of the APY to multiply your principal or balance.
Best High-Yield Savings Accounts: How to Earn More Interest
In addition to showing you how to calculate interest on your savings account, we would also like you to earn more interest on your bank deposit. Did you just ask how? It’s quite simple. Switch to a high-yield savings account. Learn how to switch banks in this post.
To earn a lot of money from the strongest interest rates (APYs) on the market, open a savings account with the banks and financial institutions listed below. They provide the best savings accounts with great perks and operate under strong regulations to guarantee a safe and enjoyable banking experience.
Migom Bank
Migom Bank is an online financial services provider for individuals and businesses to save money, spend wisely, and invest in short-term and long-term traditional assets and digital currencies. It is one of the few leading crypto-friendly banks in the world. Open an account with Migom Bank and get a Certificate of Deposit in Savings Accounts that can pay you up to 5.5% interest in USD, EUR, and GBP.
Monzo
Monzo is a neobank that boasts of having all it takes to replace your traditional bank account. It offers many advantages to consumers with an eye for innovative banking. You can grow your savings with Monzo’s Pots and the automated savings challenge, earning up to 4.30% interest on your fixed deposit for 12 months. Just maintain a minimum balance of £500 and leave the rest to Monzo. Register for Monzo savings account here and start earning more interest. We would also like you to check our selection of the best alternatives to Monzo.
bunq
bunq is the digital bank of the free, allowing customers to earn high interest on its Easy Savings account without paying any fees. It pays 0.27% interest monthly on your deposit, which is an estimate of 3.24% APY. Create a savings account with bunq to have a fully mobile banking app that gives you the freedom you need to save, spend, budget, and invest without stress.
Capital One
Capital One is an online banking service and mobile app that provides a single platform for you to effortlessly manage all your finances. Its savings account offers a 2.35% APY to enable you to earn more when you save more. There are no monthly or maintenance fees and no minimum balance requirement. Sign-up for savings account with Capital One.
Zopa
Zopa completely moved from being a peer-to-peer lender to being a challenger to established retail banks. It now provides smarter savings accounts, allowing customers to split their deposits into personalised pots. You can start with £1 and save up to £85,00 under guaranteed deposit protection by the Financial Services Compensation Scheme in the UK. Zopa Bank offers savings accounts with interest rates that range from 2.12% to 2.55%. Get a Zopa account today.
How to Maximise Your Earnings
If you want to grow your income without depending on a savings account, you might want to consider using some money-saving apps. Moreover, you can follow our money-saving tips, use our inflation impact reduction techniques when prices are soaring, invest in some long-term assets, and make money on cryptocurrency.
Debt can affect your ability to grow your money, and a common way for people to run into debt is by making avoidable mistakes when opening their credit cards. If you owe more than you earn, you are not fully in control of your money. You need to find ways to save money by learning how to pay off credit card debt and knowing the expenses you should never charge on your credit card.
FAQ
Yes, you can. Depending on your lifestyle, this amount could cover your living costs, housing and shelter expenses, healthcare, and other bills. However, you need to ensure that you are not just spending but also investing some of it. Otherwise, you might use up all of it in a short while. Besides, your personal budgeting skills will also determine how far you can go with earning this high interest.
This depends on the compound interest rate. If we assume that the interest rate is 6%, then a $20,000 deposit today will be worth about $64,000 in 20 years. This means that you will have earned more than double your initial investment ($44,000).
Yes, your money is safe in an online saving account provided that the bank or financial institution is one of the best in the market. In other words, you need to ensure that the savings account provider is regulated, licensed, accounts are insured, and the company operates at international standards.
It is quite right to say that it doesn’t make sense to save money when the inflation rate is higher than the APYs of savings accounts offered by banks. But, essentially, the purpose of a savings account is not to make so much money from earning interest. It is to help you have an emergency fund or put money aside for something you need to obtain in the future. If you want to make money from interest, you should invest in various financial instruments instead of depositing cash in savings accounts.
What should you do in a time of high inflation? We recommend that you create a realistic budget that includes a small amount of money you can save in high-yield interest accounts and take your mind away from the interest rate. Add whatever amount you are able to contribute each month, no matter how small. When uncertainty sets in, you will be glad you did not spend all your money.
Generally, brick-and-mortar banks have more administrative expenses and spend more on their costs of operations than online banks. That is a simple reason why they are not able to offer high interest rates on savings accounts like online banks.
Grow Your Money Now!
You now know how to calculate the interest on a savings account and the benefits you can get from doing it. Additionally, you have gained a better understanding of how compound interest works and how it increases your savings account balance over time. To ensure that you get the greatest rate possible when you move banks, we have also included the top high-yield savings account providers in this post. Make use of this knowledge to your advantage. Now is the time to grow your money!
