Banks pay interest by calculating a percentage of your account balance and crediting that amount to your account on a set schedule—usually monthly or daily, depending on the bank and account type.
The interest rate your bank offers is set by the bank itself, not by the government. It moves up and down based on what the Federal Reserve does with its benchmark interest rate, but your bank decides how much of that change reaches your account. A bank might offer 0.01% APY on one savings account and 4.50% APY on another, even though both are savings accounts at the same institution.
The actual dollar amount you earn depends on three things: the interest rate the bank advertises, how much money sits in your account, and how often the bank compounds the interest—meaning how often it calculates interest on your interest. A bank that compounds daily will pay you slightly more than one that compounds monthly, even at the same advertised rate.
Key Takeaways
- Banks calculate interest as a percentage of your balance and credit it to your account on a schedule—usually monthly, daily, or quarterly.
- The interest rate varies by bank and account type; the Federal Reserve's rate influences what banks offer, but does not set it.
- Compounding frequency matters: daily compounding pays more than monthly compounding at the same rate, because you earn interest on your interest.
- Your bank must disclose the APY (annual percentage yield) and compounding method before you open the account, usually in the account disclosure document.
What APY means and how it differs from the interest rate
APY stands for annual percentage yield. It is the total percentage return you will earn in one year if you leave your money untouched and the rate does not change. APY includes the effect of compounding, so it is always equal to or higher than the base interest rate.
The base interest rate (sometimes called the nominal rate) is what the bank uses to calculate each compounding period. If a bank offers 4.50% APY with daily compounding, the actual daily rate is lower—roughly 0.0123% per day—but when compounded over a year, it adds up to 4.50% APY. Banks must show you the APY, not just the base rate, so you can compare accounts fairly across different banks.
When you see a savings account advertised at "4.50% APY," that 4.50% is what you will earn in a year if the rate stays the same and you do not withdraw money. If you withdraw money partway through the year, you earn less because your balance was lower for part of the time.
How the compounding schedule affects what you earn
Compounding is when a bank calculates interest on the interest you have already earned. The more often a bank compounds, the more you earn, because each time it compounds, the new interest gets added to your balance, and the next calculation includes that new amount.
Here is a concrete example. Say you have $10,000 in a savings account at 4.00% APY. If the bank compounds monthly, it divides the annual rate by 12 (roughly 0.333% per month), calculates interest on your balance, and adds it. The next month, it calculates interest on the new, slightly higher balance. If the bank compounds daily instead, it divides the rate by 365, calculates interest every day, and adds it every day. Over a year, daily compounding will pay you a few dollars more than monthly compounding, even though the APY is the same.
Most banks compound daily or monthly. Some older accounts or very small banks may compound quarterly or annually. The bank's account disclosure document (sometimes called a Truth in Savings disclosure) will state the compounding frequency. You can ask the bank directly if it is not clear.
When and how often banks credit interest to your account
Banks calculate interest continuously (usually daily), but they credit it—actually add it to your balance—on a schedule. Most banks credit interest monthly, meaning you see the payment hit your account once a month. Some banks credit it quarterly (four times a year) or even annually.
The day interest posts varies by bank. Some post on the last day of the month, others on the first business day of the next month. A few post on a specific date like the 15th. Your bank's disclosure document will say when interest posts. If it does not, call and ask—it matters if you are trying to time a withdrawal or deposit.
Once interest is credited, it becomes part of your balance and earns interest itself in the next compounding period. If your bank compounds daily but credits interest monthly, the bank is calculating daily but only showing you the total once a month. The effect is the same as if it credited daily—you still earn the full APY—but you only see the deposit once a month.
Why interest rates change and what that means for your account
Banks change their savings account rates based on what the Federal Reserve does. When the Federal Reserve raises its benchmark rate, banks typically raise the rates they offer on savings accounts. When the Fed lowers its rate, banks usually lower savings rates too. However, banks do not always move their rates at the same time or by the same amount. Some banks raise rates quickly but lower them slowly, or vice versa.
If your bank changes your interest rate, it must notify you before the change takes effect. The notification usually comes by email, mail, or a message in your online banking portal. The bank can lower your rate, but it cannot do so without telling you first. You can then decide whether to keep the account or move your money elsewhere.
Rate changes do not affect interest you have already earned. If you earned $50 in interest last month at 4.50% APY, and the bank drops the rate to 3.75% APY this month, you keep the $50. Only future interest is calculated at the new rate.
How to find out what rate your bank is paying you
Your bank discloses the interest rate and APY in the account disclosure document you receive when you open the account. This document is required by federal law and must include the APY, the compounding method, and when interest is credited. You can request a copy from your bank at any time, or find it in your online banking portal under account details or disclosures.
If you already have an account and want to know the current rate, log into your online banking, call the customer service number on the back of your debit card, or visit a branch. Banks are required to tell you the rate on your account. Some banks also post current rates on their website, though the rate you see there may not be the rate on an older account—banks often offer different rates to new customers than to existing ones.
You can also use a rate comparison tool like Bankrate or DepositAccounts to see what other banks are offering. These sites do not show you what you personally will earn, but they show you what is available in the market, which helps you decide whether to move your money.
The difference between savings accounts, money market accounts, and CDs
Savings accounts, money market accounts, and certificates of deposit (CDs) all earn interest, but the rates and rules differ. A savings account typically has the lowest rate but lets you withdraw money anytime without penalty. A money market account usually pays slightly more but may require a higher minimum balance and limits how many times you can withdraw per month. A CD pays the highest rate but locks your money away for a set time—three months, one year, five years—and charges a penalty if you withdraw early.
Banks calculate and credit interest the same way across all three account types: as a percentage of your balance, compounded on a schedule, and credited on a schedule. The difference is what you can do with the money and what rate the bank offers. If you need access to your money, a savings account makes sense even if the rate is lower. If you know you will not touch the money for a year, a CD will pay you more.
Frequently Asked Questions
Why does my bank pay me less interest than another bank?
Banks set their own rates based on their costs and strategy. A bank with lower operating costs or one that does not need deposits as urgently may offer higher rates. Online banks often pay more than brick-and-mortar banks because they have lower overhead. The rate also depends on the account type—a premium savings account pays more than a basic one at the same bank.
If I withdraw money partway through the month, do I lose all the interest I earned?
No. Interest accrues daily, so you earn interest on the money you had in the account for the days it was there. If you had $10,000 for 15 days and then withdrew it, you earn interest on $10,000 for 15 days, not the full month. You do not lose what you already earned, but you earn less because your balance was lower for part of the period.
Can a bank change my interest rate without telling me?
No. Banks must notify you before lowering your rate. The notification comes by email, mail, or online message. You have the right to close the account if you disagree with the new rate. Banks can raise your rate without notice, but they must tell you before lowering it.
Is the interest I earn on a savings account taxable?
Yes. Interest earned on a savings account is taxable income. If you earn $25 or more in interest in a year, your bank will send you a 1099-INT form in January, and you report that income on your tax return. Even if you earn less than $25, the interest is still taxable—you just may not receive a form.
What happens to my interest if the bank fails?
Your account and all interest earned on it are protected up to $250,000 by the FDIC (Federal Deposit Insurance Corporation) if your bank fails. Interest accrued but not yet credited is also covered. If your balance is above $250,000, only the first $250,000 is protected, so the interest on the excess is at risk.