One advantage to 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 savings account earning a nickel or dime per month in interest. It’s also why your account’s annual percentage yield (APY) is so important. A low APY means your savings grow at a snail-like pace.
Here’s how savings account interest works and how it’s affected by other savings account types. This guide might even help you make more money on 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. You’ll get a better interest rate if you’re storing a large amount of money for good keeping — and a worse 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 competitive rate. Most consumers earn a fraction of that amount on their savings.
If you have a legacy savings account at Bank of America, for example, you might only earn 0.01% APY on your money. Based on your balance, that could translate to about a nickel per month.
Savings accounts like this are more about storing your money than growing it. This is because lower APYs mean 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 that time:
Where a savings account can become more rewarding is when your interest earns interest. This is called compound 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 using a free compound interest calculator.
Here’s one example in which you’d contribute $500 monthly to a $10,000 account for 10 years:
Monthly compounding allowed this account to grow by more than $3,000 in 10 years. 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 you might encounter to open and maintain your savings account.
Requirements could include a minimum opening deposit and maintaining a minimum daily or monthly balance. On the positive side, some banks have a tiered yield structure, increasing your APY 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 or by checking out our banking marketplace.
Here are the typical ranges of interest rates on savings accounts, according to consumer research firm ValuePenguin:
- Regular savings accounts: 0.01% to 0.25%
- Online savings accounts: 0.75% to 1.00%
- Money market accounts: 0.04% to 0.10%
- Certificates of deposit (CDs): 0.01% to 1.65%
You’ll also want to examine the uses of the account itself. As much as the rate might attract your attention, the other details matter.
1. Regular savings accounts
The products of big banks, community banks, and credit unions aren’t created equal. At Bank of America, 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’ll 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. With an HSBC Premier Savings account, for example, your yield is tiered by account balance:
|$0 – $24,999.99||0.01%|
|$25,000 – $99,999.99||0.10%|
|$100,000 or more||0.15%|
If giving up in-person customer service is not a big deal to you, opening an online savings account with a reputable 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 are able to 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, comes with a savings account interest rate of 1.20%. Lacking ATM service, it does allow customers to transfer money to and from other banks.
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 money on hand.
Often requiring a higher minimum balance than savings accounts, money market accounts can 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 BofA account with a 0.01% APY. 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
The most unique of these four accounts, a certificate of deposit (CD) account forces you to stow away 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 true: 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 money 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 (1.34%) bested that of banks (1.15%), according to SNL Financial.
Consider savings account interest rates in context
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 another, 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 a savings account.
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