Your Guide to Savings Account Interest (If You’re Not a Math Whiz)

One advantage of saving money with a bank is that it can grow faster there than it can under your mattress. How much faster exactly?

It’s a legitimate question if you have a big-bank savings account weighed down by a 0.01 interest rate.

This is why annual percentage yield (APY) is so important. Your account’s low APY – the 0.01 interest rate or slightly better – causes the snail-like pace of growth.

Here’s how savings account interest works in general, what affects it, including the different savings account types. Picking up this know-how might help you make more money with your money.

How does savings account interest work?

Although you might be more familiar with the term annual percentage rate (APR) thanks to your student loans and credit card, APY is what you’re looking for in a savings account. You’ll see banks advertising this figure alongside their account offerings.

Banks offer interest to entice customers to open new accounts and grow their money over time. They will give you a better interest rate if you’re storing a large amount of money for longer periods – and a less competitive interest rate if you have a lower balance from which you often make withdrawals.

These days, a 1.00% APY on a savings account is a real boon given the Federal Reserve’s recent rate cuts amid the COVID-19 crisis and its impact on the economy. Most consumers earn a fraction of that 1.00% on their savings accounts.

If you have a legacy savings account at Bank of America, for example, you might only earn 0.01 interest rate on your money. Depending on your balance, that could translate to about a nickel per month.

What does a 0.01 interest rate mean?

If your savings account is tagged with a measly 0.01 interest rate, the account is more for storing and accessing your money than for growing it. This is because such a low APY means more modest returns.

Consider, for example, you contribute $100 per month to your existing $10,000 savings account for the next year. Here’s how much interest you would earn in a year:

0.01 interest rate: $1 0.50 interest rate: $53 0.00 interest rate: $106

Where savings account interest can become more rewarding is when it gathers its own interest over time. This is called compounding interest, and APY – unlike APR – accounts for it.

If your account compounds monthly, you’ll earn interest on your new account total, which includes the previous month’s interest. It’s easier to understand this concept by learning the compound interest formula.

Here’s one example in which you’d contribute $500 monthly (or $6,000 annually) to a $10,000 account for 10 years:

Monthly compounding allowed this account to grow by more than $4,000 in 10 years with just interest. It’s important to know how often your savings account compounds interest, whether it’s daily, monthly or quarterly. The more often, the better it is for you.

What affects interest rates on savings accounts?

The federal funds rate (FFR) helps determine what kind of rate you could secure at a bank. When the FFR is high, it’s good news for savers because banks might be willing to pay higher yields on customers’ savings.

When you become a bank’s customer, you agree to a set of terms. You know your savings account interest rate and whether it’s fixed or variable. You also know how often interest will be deposited into your account.

There’s some wisdom behind chasing the highest APY available. But the higher the yield, the more requirements there are to open and maintain a savings account.

Requirements could include making an initial deposit of a certain value and maintaining a large enough monthly balance. On the positive side, some banks have a tiered-yield structure, increasing your APY (or sign-up account bonus) after your account surpasses milestone values like $25,000 or $50,000.

That said, your interest rate on savings accounts is somewhat dependent on the type of account you open.

Interest rates for 4 types of savings accounts

Like the APR of a student loan, the APY of a savings account is just one factor to consider. You’ll want to compare rates by shopping around from bank to bank – and comparing different account types, including:

1. Regular savings accounts 2. Online savings accounts 3. Money market accounts 4. Certificates of deposit (CDs)

1. Regular savings accounts

The products of big banks, community banks and credit unions aren’t created equal. At J.P. Morgan Chase, for example, you gain the convenience of ATMs throughout the country but give up significant savings account interest.

At a local bank or a credit union, you’d likely score a higher APY but perhaps give up the ability to house all your accounts in one place. It’s important to ask which kind of institution is right for you.

Within each of these banks, there are differences in savings account interest rates. At HSBC, for example, your yield is tiered by account balance. Here are the resulting APYs as of Sept. 16, 2020:

And, yes, if 0.01 interest rate is weighing your money down, you might question whether it’s worth having a savings account at all.

2. Online savings accounts

If in-person customer service is not a big deal to you, opening a savings account with a reputable online bank could be a no-brainer. That’s because their APY offerings are almost always higher than banks that have brick-and-mortar branches.

Online banks offer higher APYs because they have fewer expenses. They don’t have full-time tellers welcoming you into a physical building, for example.

The online-only bank Barclays, for example, promises a savings account interest rate of five times the national average. Lacking ATM service, it does allow customers to transfer money online to and from other banks. And it doesn’t have an account minimum.

3. Money market accounts

Although you can open a bank account at a branch or online without making a deposit or maintaining a minimum balance, money market accounts are suited for savers with more cash reserves.

Often requiring a minimum commitment of $1,000, money market accounts come with more fees that could cut into your interest dividends. Dropping below $1,000, for example, could lead you to pay a $10 monthly fee.

All in all, the yields of money market accounts are generally higher than those of regular savings accounts.

Say you throw $5,000 in a money market account with a 0.10% APY, and you also stash $5,000 in a traditional bank account with a 0.01 interest rate. In two years, the money market account would gain $10 in interest, and the regular savings account would grow by just $1.

But because the money isn’t locked away, your money won’t grow as fast as it would sitting in a CD.

4. Certificates of deposit (CD)

The most unique of these four accounts, a CD calls for sealing off a specific amount of your money for a predetermined period. You might agree to a fixed APY beforehand or tie your interest rate to the market.

Either way, this fact holds: The more money you leave with your bank – and the longer you leave it there – the higher APY you can expect.

In exchange, you give up access to your money. In fact, there are penalties for early withdrawals, making CDs a good option if you don’t need to touch your account for a while. Most CDs start at three months and can go up to six or more years in length.

There’s also a benefit of opening your CD with a credit union, where the average five-year APY (1.14%) bested that of banks (0.92%), according to the National Credit Union Association’s (NCUA) June 2020 report.

Rid yourself of the 0.01 interest rate – but not at all costs

Savings account interest is one factor to consider when working with your bank, but it’s not the only factor. You wouldn’t want to hamstring your finances, for example, by stashing money in one account just to be able to secure a slightly higher APY.

Consider all aspects of an account before opening one. For example, even if one bank offers a higher APY than your current bank’s paltry 0.01 interest rate, its branches might not be conveniently located for you. Or maybe it has higher fees if your balance drops below a certain amount.

Get a feel for what matters to you beyond the interest rate. That will help you pick the right savings account, whether you’re saving up for college or trying to pay off debt.

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