Banks pay you interest on savings accounts, not the other way around
When you put money in a savings account, the bank pays you interest as compensation for letting them use your money. The bank lends that money to other customers as mortgages, car loans, and business loans—and charges them higher interest rates. The difference between what the bank pays you and what it charges borrowers is how the bank makes money on your account.
The interest rate your bank offers varies based on the current economic environment, the bank's own costs, and what type of account you open. A high-yield savings account at an online bank might pay 4% to 5% annually, while a traditional savings account at a brick-and-mortar bank might pay 0.01% to 0.5%. The Federal Reserve's interest rate decisions ripple through the entire banking system and affect what banks are willing to pay.
Interest accrues either daily or monthly, depending on the account. Most banks calculate interest daily but credit it to your account monthly or quarterly. This means your balance grows slightly each statement period, even if you never make a deposit.
Key Takeaways
- Banks pay you interest on savings accounts because they use your deposits to make loans to other customers at higher rates.
- Interest rates on savings accounts range from nearly 0% at traditional banks to 4% to 5% at online banks, depending on current market conditions and the bank's business model.
- Interest compounds over time, meaning you earn interest on your interest, so the longer money sits in the account, the more it grows.
- The Federal Reserve's benchmark rate directly influences what banks pay on savings, so rates change when the Fed adjusts its policy.
How interest rates are set and why they change
The Federal Reserve sets a target range for the federal funds rate—the interest rate banks charge each other for overnight loans. When the Fed raises this rate, banks have higher costs and tend to raise the rates they pay on savings accounts. When the Fed lowers it, savings rates typically fall as well. The Fed has raised rates significantly since 2022, which is why savings account rates are higher now than they were in 2020 and 2021.
Individual banks also set their own rates based on how much money they need to attract. A bank that has plenty of deposits and doesn't need more customer money might offer lower rates. A newer online bank trying to build its customer base quickly might offer higher rates to stand out. This is why you can see a 4% difference between the best and worst savings rates on the market at the same time.
Banks are not required to pass along Fed rate increases to savers, and they often don't pass them along fully. When the Fed raised rates, some traditional banks increased savings rates by only a fraction of a percentage point, while online banks raised theirs much more. This gap is one reason why shopping around for a savings account makes a real difference to your money.
How compound interest grows your balance over time
Compound interest means you earn interest on the interest you've already earned. If you have $10,000 in a savings account earning 4% annually, you earn $400 in the first year. In the second year, you earn 4% on $10,400, which is $416. The extra $16 comes from earning interest on your first year's interest.
The longer money stays in the account, the more powerful compounding becomes. Over 10 years, that same $10,000 at 4% grows to roughly $14,800—not because you added money, but because of compounding. At 0.5%, the same $10,000 grows to only about $10,500 over 10 years. The difference between a high-yield account and a traditional savings account is thousands of dollars on larger balances.
How often interest compounds matters too. Most savings accounts compound daily, which is better than monthly or quarterly. Daily compounding means the bank calculates interest on your balance every single day, so you earn slightly more than if it were calculated once a month. The difference is small on small balances but adds up on larger ones.
What happens when interest rates fall
When the Federal Reserve lowers its benchmark rate, banks eventually lower the rates they pay on savings accounts. This happened in 2023 and 2024, when the Fed began cutting rates after years of increases. If you had a savings account earning 5% in mid-2023, that same account might earn 4% or less by early 2024.
Banks lower rates on existing accounts without asking permission—the rate you earn straightforward drops on your next statement. You don't lose the money you've already earned, but future interest accrues at the lower rate. This is why some people move their money to a different bank when rates fall; if your current bank drops its rate but competitors haven't, you can earn more elsewhere.
Rate drops are also why it's worth checking your savings account rate periodically. Many people open a high-yield account, earn a competitive rate for a year or two, then forget about it while the rate quietly drops to 1% or less. Setting a reminder to check your rate every six months helps you catch when it's time to move your money.
The difference between savings accounts and money market accounts
Money market accounts are a hybrid between savings accounts and checking accounts. They typically pay interest rates similar to or slightly higher than savings accounts, but they also come with a debit card and check-writing privileges. The tradeoff is that they usually require a higher minimum balance and limit how many withdrawals you can make per month.
Both savings accounts and money market accounts are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor per bank. This means your money is protected even if the bank fails. The interest rate difference between the two is usually small enough that the choice comes down to whether you need check-writing or a debit card.
Why some accounts charge fees that eat into interest earnings
Some banks charge monthly maintenance fees on savings accounts, typically $5 to $10. If your account earns $2 in interest per month but costs $5 to maintain, you're actually losing money. This is one reason why online banks often offer better deals—they have lower overhead costs and can afford to charge no fees and pay higher rates.
Read the account disclosure carefully before opening a savings account. Look for monthly maintenance fees, fees for falling below a minimum balance, and fees for exceeding a withdrawal limit. Many online banks have no fees at all, so paying fees at a traditional bank means you're giving up money for no reason.
Some banks waive fees if you maintain a certain balance or set up direct deposit. If you can meet those conditions, the account might still be worth it. But if you can't, a no-fee online account will almost always leave you with more money.
How to compare savings account rates across banks
The easiest way to compare rates is to visit bank websites directly or use a rate comparison tool that tracks current rates across multiple banks. Look at the Annual Percentage Yield (APY), not just the interest rate—APY includes the effect of compounding and shows you the true return on your money. A bank advertising "4% interest" might actually pay 4.05% APY when compounding is factored in.
Check whether the rate is promotional or permanent. Some banks offer a high rate for the first three months to attract new customers, then drop it significantly. The disclosure should say whether the rate is may provide or subject to change. A may provide rate is better, but all rates can change when the Fed adjusts policy.
Don't assume the biggest bank has the best rate. The largest banks often pay the lowest rates because they don't need to attract deposits aggressively. Smaller online banks and credit unions often pay more. As long as the bank is FDIC-insured (or the credit union is insured by the National Credit Union Administration), your money is equally safe.
Frequently Asked Questions
Can a bank take back the interest I've already earned?
No. Once interest is credited to your account, it's yours. The bank can lower the rate on future interest, but it cannot remove interest you've already received. If you close the account, you keep all the interest that was credited before you closed it.
What's the difference between APR and APY on a savings account?
APR (Annual Percentage Rate) is the interest rate without compounding. APY (Annual Percentage Yield) includes the effect of compounding. On a savings account, APY is always higher than APR because you earn interest on your interest. Banks must disclose APY, so that's the number to use when comparing accounts.
Do I have to pay taxes on savings account interest?
Yes. Interest earned on a savings account is taxable income. The bank will send you a Form 1099-INT if you earn $10 or more in interest during the year, and you must report it on your tax return. The amount you owe in taxes depends on your tax bracket.
Why is my savings account earning almost nothing?
Traditional banks often pay rates below 0.5% because they don't need to compete aggressively for deposits. Online banks and credit unions typically pay 4% to 5% on savings accounts. If your bank is paying less than 1%, moving your money to a higher-paying account could earn you significantly more without any additional effort.
Does moving my money to a different bank hurt my credit?
No. Opening a savings account and moving money between banks does not affect your credit score. Credit scores are based on borrowing and repayment history, not on where you keep your deposits. You can move your money as many times as you want without any credit impact.