Interest is money the bank pays you for letting them use your deposits

When you put money in a savings account, the bank lends that money out to other customers as mortgages, car loans, and business credit lines. The bank keeps the difference between what it pays you and what it charges borrowers. That payment to you is interest—usually expressed as an annual percentage rate, or APR.

The amount you earn depends on three things: how much you have in the account, what interest rate the bank offers, and how long the money sits there. A $5,000 balance at 4.5% APR earns differently than $5,000 at 0.01% APR, and both earn differently depending on whether interest compounds daily, monthly, or annually.

Banks are not required to pay interest on savings accounts. Some do; some do not. The rate changes whenever the bank decides to change it, which usually happens when the Federal Reserve adjusts its benchmark rate, but banks move on their own schedule.

Key Takeaways

  • Interest is calculated as a percentage of your account balance and paid by the bank on a schedule it sets—usually monthly or daily.
  • The annual percentage rate (APR) tells you what you would earn in a year, but most banks compound interest daily or monthly, so you earn slightly more than the straightforward APR suggests.
  • Your balance changes the interest you earn: a higher balance earns more, and interest earned gets added to your balance and earns interest itself the next period.
  • Banks can change their interest rates at any time without notice, so the rate you see today may be different next month.

How the bank calculates what you earn each period

Banks use a formula: Interest = (Balance × APR) ÷ Number of compounding periods per year. If you have $10,000 at 4.5% APR and the bank compounds monthly, you earn ($10,000 × 0.045) ÷ 12 = $37.50 that month.

The catch is that most banks compound daily, not monthly. Daily compounding means the bank calculates interest on your balance every single day, adds that day's interest to your account, and then calculates the next day's interest on the new, slightly higher balance. Over a year, daily compounding earns you more than monthly compounding on the same APR.

Here is a concrete example. Say you have $10,000 at 4.5% APR with daily compounding. The bank calculates your daily interest as ($10,000 × 0.045) ÷ 365 = $1.23. That $1.23 gets added to your account. The next day, the bank calculates interest on $10,001.23, earning you $1.23 plus a tiny fraction more. By the end of the year, daily compounding on 4.5% APR yields about 4.60% in actual earnings—a real difference on larger balances.

When the bank actually deposits the interest into your account

The bank calculates interest constantly, but it deposits the money on a schedule. Most banks post interest monthly, meaning you see the full month's accumulated interest hit your account on the same day each month. Some banks post quarterly or annually. A few online banks post daily.

The timing matters if you are tracking your balance or planning a withdrawal. If your bank posts interest on the 15th of each month and you withdraw all your money on the 14th, you lose that month's interest. Once interest is posted to your account, it becomes part of your balance and earns interest itself going forward.

Why your interest rate changes and what triggers it

Banks set their own rates based on what the Federal Reserve does, market conditions, and how much competition they face. When the Federal Reserve raises its benchmark rate, banks typically raise savings account rates within weeks or months. When the Fed cuts rates, banks often cut savings rates faster than they cut loan rates.

Your bank can change your rate at any time. They are not required to notify you in advance, though most send an email or letter when the rate drops. If rates rise, you usually find out when you check your account or read a statement. Online banks tend to move rates faster than brick-and-mortar banks because they have lower overhead and compete more aggressively on rate.

The rate you locked in when you opened the account is not locked in at all—it is a variable rate unless you opened a certificate of deposit (CD), which does lock in a rate for a set term. With a regular savings account, the rate floats with the market.

How balance changes affect what you earn

Interest is calculated on your balance, so a higher balance earns more. If you have $1,000 at 4.5% APR, you earn about $45 per year. If you have $10,000 at the same rate, you earn about $450 per year. The rate is the same; the balance is ten times larger, so the earnings are ten times larger.

Your balance also changes as interest gets added. If you start with $10,000 and earn $37.50 in month one, your balance becomes $10,037.50. In month two, you earn interest on $10,037.50, not the original $10,000. This is compound interest—earning interest on your interest. Over years, compounding makes a real difference. A $10,000 balance at 4.5% APR compounds to about $10,460 after one year, $10,945 after two years, and $11,461 after three years.

The difference between APR and actual earnings

The APR is a standardized number that lets you compare accounts. It tells you the annual rate before compounding. But because most banks compound daily or monthly, your actual earnings are slightly higher than the APR suggests. Banks sometimes list both the APR and the APY (annual percentage yield), which includes the effect of compounding.

On small balances or short time periods, the difference is tiny. On a $5,000 balance at 4.5% APR with daily compounding, you earn about $231 per year instead of $225—a $6 difference. On a $100,000 balance, the difference is $120. The longer your money sits, the more compounding matters.

What happens if you withdraw money mid-period

Most banks calculate interest on your average daily balance or your ending balance for the period. If your bank uses average daily balance and you withdraw half your money partway through the month, your interest for that month is lower because your average balance was lower.

Some banks have a grace period where you can withdraw money without losing interest for that period, but this is rare. Most savings accounts have no penalty for withdrawal—you can take money out whenever you want—but you lose the interest you would have earned on that money for the rest of the period.

Frequently Asked Questions

Do I have to pay taxes on savings account interest?

Yes. Interest earned on a savings account is taxable income. Banks send you a 1099-INT form at the end of the year if you earned $10 or more in interest. You report this on your tax return. The tax rate depends on your overall income and tax bracket.

Why do some banks pay almost no interest?

Banks set rates based on what they can earn lending money out and what they need to pay to attract deposits. When the Federal Reserve keeps rates very low, banks have little incentive to pay much interest. During periods of low Fed rates, many traditional banks pay 0.01% or less. Online banks and credit unions often pay more because they have lower costs and compete harder for deposits.

Can I move my money to a higher-rate account without losing interest?

Yes. Once interest is posted to your account, it belongs to you. You can transfer the full balance—original deposit plus all interest earned—to another bank without penalty. You only lose future interest if you withdraw before the next interest posting date.

What is the difference between a savings account and a money market account in terms of interest?

Both earn interest the same way: the bank calculates it on your balance and compounds it on a schedule. Money market accounts often pay slightly higher rates because they require larger minimum balances and limit how often you can withdraw. The compounding method is the same.

If I have multiple savings accounts at the same bank, do they earn interest separately?

Yes. Each account has its own balance, and interest is calculated on each balance separately. If you have a $5,000 account earning 4.5% and a $10,000 account earning 4.5%, the first earns about $225 per year and the second earns about $450 per year. They do not combine for interest calculation purposes.