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Different savings accounts come with different interest rates and different ways of calculating interest. It is important to know how interest works so that you can ensure you are getting the best value from your savings. In this article, we answer the basic questions about high-interest savings accounts so that you can better manage your money.
What is the interest rate on a savings account?
The interest rate of a savings account is the percentage of your savings that your bank will pay you for keeping your money with them for a certain period. The rate is given as the percentage by which your savings will increase if you keep them in the account for one year. This is the simplest form of an interest rate, but other factors will determine how much interest you actually earn. Other factors include whether you make further deposits, whether you withdraw funds, and how often the bank calculates and pays interest.
Why do banks pay interest on savings accounts?
Banks pay interest to you for keeping your savings with them because, in effect, they are borrowing your money. A bank will use your money to make other investments, or to lend your money to someone else at a higher interest rate. Therefore, the interest rate that a bank offers you will be proportionate to how much they think they can earn with your money in the current market.
How does interest work on a savings account?
Even though the interest rate that banks advertise is for a period of one year, you will invariably be paid interest more often than that. For example, all of Greater Bank’s savings accounts pay interest monthly (or, in a term deposit account, you can choose how often it pays).
Often, the interest to be paid on a savings account comes with certain conditions, such as that you have to deposit a certain amount of money each month, or that you maintain a minimum balance. Banks will also often advertise certain promotions to bring in new customers, such as a higher rate of interest for the first 4-6 months, or a bonus interest rate for fulfilling certain conditions (such as making large deposits). Often, accounts with bonus interest rates will have quite a low base interest rate. | Greater Bank
Greater Bank is different in that it offers one interest rate for each of its accounts, so you know what to expect from your savings. For example, the Greater Bank Life Saver Account (available to individuals under 25 years of age) simply requires that you grow your balance each month and you will receive the full interest rate. Once opened, you can also keep the account for life.
How to calculate savings interest
The way in which you calculate the interest you will earn from your savings account is dependent on two factors:
- the interest rate, and
- the rate at which your interest is compounded.
Compound interest is essentially the interest you earn on interest you have already earned. The rate at which your interest is compounded is the rate at which interest you have earned is added back to the total sum of your savings. If your interest is compounded over shorter intervals, it means that the balance against which your interest is calculated will grow faster. Different savings accounts will compound your interest at different rates - such as, daily, monthly, quarterly or annually.
To see the effect of different rates of compounding, take two savings accounts with a 5% interest rate - one compounding annually, and one compounding daily. Assume both accounts are opened with initial deposits of $10,000, and that no deposits are made afterwards.
|Compounding annually||Compounding daily|
|Value after 1 year||$10,500.00||$10,512.67|
|Value after 5 years||$12,762.82||$12,840.03|
|Value after 10 years||$16,288.95||$16,486.65|
Over time, the account that compounds interest at a faster rate will earn higher levels of actual interest, even though both accounts have the same base interest rate. This is why you should always check how exactly the interest will be calculated on particular savings accounts, and not just the advertised interest rate.
Comparing savings accounts can be more difficult if both the interest rate and the rate of compounding are different. In order to better compare savings accounts, you should look for the account’s annual percentage yield (APY). This is a percentage figure that takes into account both the interest rate and the rate of compounding. It, therefore, gives you a good idea of the actual interest you will earn over the course of one year, making it easier to compare different savings accounts.
To calculate how much interest you will earn on different savings accounts, you can also use Greater Bank’s Savings and Deposit Calculator.
What is a good interest rate for a savings account?
The interest rates that banks offer on savings accounts will go up or down quite often, depending on the market. To determine what a good interest rate is, you really need to compare what is being offered at the time you want to open an account.
But, more than focusing just on the interest rate, you should check whether the other features of the account suit your needs. For example, you might not get any benefit out of a high-interest savings account that requires you to make high monthly deposits if you can’t afford to make them. Or you might really need a savings account that allows you to make withdrawals from time to time.