How to Calculate Interest Rate on Savings Accounts

Interest rates are more meaningful once you understand how they translate into dollars in your pocket. Running the numbers can tell you how much of a financial gain you can expect when you put your money into any particular account.

How to calculate savings rate

Interest can be calculated in two ways: simple interest and compound interest. To calculate simple interest, use the formula a = r * t * p where a is the amount of total interest you will earn, r is the rate, t is the time period, and p is your principal (the account balance). Just remember that percentages are expressed as two (or more) digits past the decimal point (2% is .02, and 2.5% is .025) and when we're talking about an annual interest rate, the time period is one year.

For example, if you have $1,000 in an account that earns 1%, the formula is

a = 0.01 x 1 x 1,000

a = 10 (this is the number of dollars you'll earn)

Simple interest is easy to calculate and can give you a good idea of how much you'll earn. But with a savings account, you'll actually earn a little more. That's because savings accounts pay interest more than once a year. Instead of simple interest, you'll earn compound interest, and that's a better deal for you.

How to calculate compound interest

Interest rates on a savings account are calculated more frequently than just once a year. Each time it's calculated, the interest is added to your balance. The next time interest is calculated, you have a bigger principal balance to use in the equation.

Using the same example, let's say that interest is compounded monthly. That means that instead of earning 1% per year, you earn one-twelfth of one percent per month.

a = 0.083 x 1 x 1,000

At the end of one month, you will have $1,000.83.

Now it gets better. In the second month, you will earn the same 1/12% but you get to multiply it by the bigger balance:

a = 0.083 x 1 x 1,000.83

At this point you're already earning interest on your interest. Your balance at the end of month two is $1,001.67, which is one penny more than you would have earned with simple interest on the same amount.

If you leave this money in the bank for 10 years and the rate doesn't change, you will have $1,104.20. Conversely, if you put the money into an account that earns simple interest, the balance will only grow to $1,100 in the same amount of time.

The more money you put into your savings account, the more it matters whether the account pays simple or compound interest. Compounding interest will help you hit each savings goal faster. The vast majority of savings and money market accounts pay compound interest. Some certificates of deposit (CDs) earn simple interest.

Savings account APY

When you see the interest rate for a savings account, you'll probably see the letters APY next to the rate. That stands for annual percentage yield. It's a way of showing you how much you'll earn after compounding is taken into account. APY is always a little bit higher than the interest rate. If the APY is 1%, the annual interest rate is about 0.9901%.

You can calculate your savings account APY with the formula APY = (1 + r / n)n where r is the interest rate and n is the number of compounding periods that occur within a year (12 if interest is paid monthly, 365 if interest is paid daily). To calculate APY based on daily compounding, you'll need to use a calculator that can handle high exponents.

How to get the best savings account interest rates

Getting a good interest rate on your savings is one of the easiest money challenges you can take on. That's because unlike checking accounts and credit cards, there aren't a lot of bells and whistles to compare on savings accounts. Identify the best savings account and apply. It's your money. Change banks if you qualify for a more lucrative offer.

The essential factors to weigh include:

• Interest rate: A high-yield savings account pays more than a traditional savings account.
• Fees: Avoid paying a monthly maintenance fee because it diminishes your earnings.
• Access: Most people's needs are met with online access, but it might take a day or two for transferred funds to reach your checking account if that account is at a different financial institution. For immediate access all the time, find a savings account that comes with a debit card and fee-free ATM withdrawals at machines near you.
• Alternative account types: A money market account combines the convenience of a checking account with the higher earning potential of a savings account. Not all money market accounts pay high interest. A certificate of deposit account often pays as much or more than a high-yield savings account but you won't be able to access the money for a period of time (ranging between one month and five years, usually). Early withdrawals might be subject to penalties.

Saving money is something you can be very proud of. Reward yourself for that effort by finding the account that will make your money work as hard as you do to increase your wealth.