Banks set savings account interest rates based on what the Federal Reserve charges them to borrow, what they can earn by lending your money out, and how much competition they face for deposits

When you put money in a savings account, the bank pays you interest. That rate is not set by the bank's whim or by a formula hidden in fine print. It moves in response to three concrete things: the cost of money itself (set by the Federal Reserve), what the bank can do with your deposit, and whether other banks nearby are offering more.

The simplest way to understand this: a bank is a business. It takes your deposit, lends most of it to someone else at a higher rate, and keeps the difference. Your interest rate is what the bank is willing to pay to keep your money in the door instead of watching you move it to a competitor.

Key Takeaways

  • The Federal Reserve's interest rate is the starting point for all bank rates — when the Fed raises or lowers its rate, banks adjust what they pay savers within weeks or months.
  • Banks lend out most of your deposit to other customers and keep the spread between what they pay you and what they charge borrowers.
  • Online banks and credit unions often pay higher savings rates than large brick-and-mortar banks because they have lower overhead costs.
  • Banks compete for deposits in different ways — some raise rates to attract new money, while others rely on existing customers and brand recognition.
  • Your rate can change at any time on a savings account, so the rate you see today may not be the rate you earn next month.

How the Federal Reserve's rate becomes your savings rate

The Federal Reserve (the central bank of the United States) sets a target range for the interest rate that banks charge each other when they lend overnight. This is called the federal funds rate. Right now, that range is between 5.25% and 5.50%, but this number changes several times a year based on economic conditions.

When the Fed raises its rate, banks' cost of borrowing goes up. When the Fed lowers it, that cost falls. Banks pass these changes to savers within a few weeks to a few months. If the Fed raises rates, your savings account rate usually rises too — but not by the same amount. If the Fed cuts rates, your savings rate typically falls faster than it rose.

This is why you may have noticed your savings rate jump in 2022 and 2023. The Fed raised its rate aggressively to fight inflation, and banks raised what they paid savers to keep deposits from fleeing to money market funds and other options. As the Fed paused its increases in 2024, the competition for deposits cooled, and many banks stopped raising rates or even lowered them.

What banks do with your deposit after you hand it over

A bank does not lock your money in a vault. It lends most of it out. When you deposit $1,000 in a savings account, the bank might lend $900 of it to someone buying a car at 6% interest, keep $50 as a safety cushion (required by law), and use the remaining $50 for its own costs. The bank pays you 4% on your $1,000, pockets the difference between what it earns (6% on the car loan) and what it pays you (4%), and covers its staff, buildings, and technology from that spread.

The wider the spread the bank can maintain, the more it can afford to pay you. If the bank can only lend money at 5% but has to pay you 4.5%, the spread shrinks and the bank's profit margin tightens. This is why savings rates tend to be lower than the rates banks charge borrowers — the bank needs to make money on the difference.

Banks also hold some deposits in low-earning or non-earning reserves, and they pay for deposit insurance (through the FDIC) to protect your money. These costs come out of the spread too, which is why even in a high-rate environment, savings accounts never pay as much as a mortgage or car loan costs.

Competition between banks for your money

If every bank in your town offers 0.01% on savings, you have no reason to move your money. But if one bank starts offering 4.5%, suddenly customers have a reason to switch. Banks compete for deposits by raising rates, and they stop competing when they have enough deposits to fund their lending.

Online banks and credit unions often offer higher rates than large national banks because they have lower costs. An online bank does not pay for thousands of branch buildings and the staff to run them. A credit union is owned by its members and does not need to generate profit for shareholders. Both can afford to pay more on savings because their overhead is lower.

Large banks sometimes keep rates low because they have other ways to make money — investment services, credit cards, business accounts — and they rely on customer inertia. Many people do not move their savings even if the rate is poor, so the bank does not need to compete on rate to keep the deposit.

Why your rate can change without warning

A savings account rate is not locked in. Banks can change it at any time, and they are required to notify you before the change takes effect (usually 30 days' notice, though this varies by state). This is different from a certificate of deposit (CD), where your rate is fixed for a set term.

Banks raise rates when they need deposits — when lending is strong and they need more money to lend out, or when competitors are offering more and they risk losing customers. Banks lower rates when they have enough deposits or when the Fed cuts its rate and the cost of money falls across the market.

This is why checking your rate once a year is worth doing. If your bank has dropped its rate to 0.01% but online banks are offering 4%, you are leaving money on the table by staying put.

The difference between what banks pay and what they charge

The gap between what a bank pays savers and what it charges borrowers is called the net interest margin. Right now, this margin is wider than it has been in years because banks are paying savers less than the Fed's rate would suggest they should.

Here is a real example: the Fed's rate is 5.25% to 5.50%. A large national bank might pay 0.01% on savings but charge 8% on a car loan. The spread is enormous. An online bank might pay 4.5% on savings and charge 7% on a car loan. The spread is smaller, but the online bank still makes money and pays you more.

Banks can maintain a wide spread when customers are not paying attention or do not know they have options. As soon as customers start moving money to higher-paying accounts, the spread narrows because banks have to raise rates to compete.

How to know if your bank's rate is competitive

The easiest way to check is to visit a few bank websites and compare their advertised rates. Look at online banks, credit unions in your state, and the national banks you know. Write down the rates and the account types — a money market account might pay more than a regular savings account at the same bank.

Keep in mind that rates change frequently, so a comparison you do today may be different in a month. But if your current bank is paying 0.01% and you find banks paying 4% or higher, that difference adds up fast. On $10,000, the difference between 0.01% and 4% is about $400 per year.

You do not need to stay with a bank that is not paying you fairly. Moving money takes a few days and costs nothing. Banks know this, which is why they raise rates when they sense customers are leaving.

Frequently Asked Questions

Why do online banks pay more than big banks?

Online banks have no physical branches, so they spend far less on buildings, staff, and overhead. They pass those savings to customers by paying higher rates on deposits. They still make money on the spread between what they pay you and what they charge borrowers — they just do it with lower costs.

If the Fed raises rates, why doesn't my bank raise my rate right away?

Banks are not required to raise savings rates when ready when the Fed moves. They raise rates when they need deposits or fear losing customers to competitors. Large banks with stable customer bases may wait weeks or months. Online banks and credit unions often raise rates faster because they compete on rate.

Can a bank lower my rate without telling me?

No. Banks must notify you before lowering your rate, usually 30 days in advance. You can then move your money to another bank if you want. The notification requirement exists to give you a chance to shop around before the change takes effect.

What happens to interest rates during a recession?

The Fed typically lowers its rate during a recession to encourage borrowing and spending. As the Fed cuts, bank savings rates fall too. This means your savings account will earn less, but borrowing costs (for mortgages, car loans, credit cards) also fall. The spread between what banks pay and charge usually widens during recessions.

Is there a savings account that locks in a rate?

Yes — a certificate of deposit (CD) locks your rate for a set term, usually three months to five years. In exchange, you agree not to withdraw the money until the term ends. If you withdraw early, you pay a penalty. A regular savings account has no term and no penalty, but the rate can change anytime.