Interest is calculated on your balance and paid to you at intervals set by your bank

Your bank takes the money you deposit, lends it out, and pays you a portion of what it earns. That payment is interest. The amount you receive depends on three things: how much money sits in your account, what interest rate the bank offers, and how often the bank compounds—meaning how often it adds earned interest back into your balance so the next calculation includes it.

Banks do not calculate interest the same way. Some use daily balance, some use monthly average balance, and some use the lowest balance you held during the period. The difference between these methods can be significant over time, especially on larger balances or higher rates.

Key Takeaways

  • Interest is calculated using your account balance multiplied by the annual interest rate, divided by the number of days in a year, then multiplied by the number of days the money sat in the account.
  • Daily compounding means interest earned each day gets added back to your balance, so the next day's interest calculation includes yesterday's interest.
  • The method your bank uses to calculate your balance—daily, monthly average, or lowest balance—directly affects how much interest you receive.
  • Interest is typically paid monthly, quarterly, or annually depending on the account type and bank, and you can see the exact calculation on your statement.

The basic formula banks use

The standard formula is: Interest = (Balance × Annual Interest Rate) ÷ 365 × Number of Days. If you keep $10,000 in an account earning 4.5% annual interest for 30 days, the calculation is ($10,000 × 0.045) ÷ 365 × 30, which equals $36.99. That is the interest you would earn in that 30-day period.

Some banks use 360 days instead of 365, which slightly increases the interest you earn. This is called the ordinary interest method. Most banks use 365 days, called the exact interest method. The difference is small on any single calculation but compounds over months and years.

The formula assumes a constant balance. In real accounts, your balance changes when you deposit or withdraw money. That is why the method your bank uses to measure your balance matters.

How daily balance method works

With daily balance, the bank calculates interest on the exact balance you held each day, then adds those daily amounts together at the end of the period. If you had $10,000 for 15 days, then withdrew $2,000 and held $8,000 for the remaining 15 days of the month, the bank calculates interest on $10,000 for 15 days and interest on $8,000 for 15 days separately, then adds them.

Daily balance is the most common method for savings accounts because it rewards you for keeping money in the account longer. If you withdraw money mid-month, you lose interest only on the days after the withdrawal, not on the entire month.

Your bank statement will show the daily balance method in the interest calculation section, sometimes labeled "interest calculated on daily balance" or "daily average balance."

How monthly average balance method works

Monthly average balance adds up your balance on each day of the month and divides by the number of days. If your balance was $10,000 for 20 days and $8,000 for 10 days, your average balance is ($10,000 × 20 + $8,000 × 10) ÷ 30, which equals $9,333.33. Interest is then calculated on that average.

This method is less common for savings accounts but appears in some money market accounts and older account types. It smooths out the effect of deposits and withdrawals, so a single large withdrawal does not drop your interest as sharply as daily balance would.

How lowest balance method works

Lowest balance uses the smallest amount your account held during the period, regardless of when it occurred. If your balance was $10,000 most of the month but dropped to $5,000 for a single day, interest is calculated on $5,000 for the entire month. This method is rare on savings accounts because it penalizes you heavily for any withdrawal.

You will see lowest balance most often on older savings products or accounts with minimum balance requirements. Most banks have moved away from this method because it discourages customers from accessing their own money.

Compounding: how interest earns interest

Compounding means the bank adds interest you have earned back into your balance, so the next interest calculation includes it. With daily compounding, interest is added every day. With monthly compounding, it is added once a month. With annual compounding, it is added once a year.

The difference compounds over time. On $10,000 at 4.5% annual interest, daily compounding earns you roughly $460 per year, while annual compounding earns roughly $450. Over five years, that gap widens to hundreds of dollars. Most savings accounts now offer daily compounding because rates are low enough that the difference is small, but it still works in your favor.

Your account statement will specify the compounding frequency. Look for language like "interest compounded daily" or "compounded monthly."

When and how often interest is paid

Interest is credited to your account—meaning actually deposited—on a schedule set by your bank. Most savings accounts credit interest monthly, though some do it quarterly or annually. High-yield savings accounts typically credit monthly. Money market accounts vary.

The crediting date is different from the calculation date. Your bank may calculate interest daily but credit it only once a month. On your statement, you will see a single line item showing the total interest earned that month, even though it was calculated daily.

You can see the exact dates and amounts on your statement. Look for a line labeled "interest paid" or "interest credited" with the date and dollar amount. If the amount seems wrong, you can verify it using the formula and your daily balance history.

Why your interest rate changes

The interest rate your bank pays on savings accounts is not fixed. Banks set rates based on what the Federal Reserve does with its benchmark rate. When the Fed raises rates, banks usually raise savings rates within days or weeks. When the Fed cuts rates, banks cut savings rates faster than they raise them.

Your bank can change your rate at any time with notice, usually 30 days. You will see the new rate reflected in your next interest calculation. If you want to lock in a higher rate, some banks offer certificates of deposit (CDs), which may provide a fixed rate for a set period.

Frequently Asked Questions

Why does my interest amount not match what I calculated?

The most common reason is that your balance changed during the month. If you deposited or withdrew money, the bank calculated interest on different balances for different days. Check your statement for the daily balance history, then recalculate using the formula with those exact balances and dates. Also verify your bank uses 365 days, not 360.

Does interest get taxed?

Yes. Interest earned on savings accounts is taxable income. Your bank will 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. Some accounts, like certain retirement savings accounts, have different tax rules.

Can I earn interest on interest?

Yes, that is compounding. When your bank credits interest to your account, that interest becomes part of your balance. The next calculation includes it, so you earn interest on the interest you already earned. Daily compounding means this happens every day, which is why it produces slightly more total interest than annual compounding.

What happens to my interest if I withdraw money before the month ends?

With daily balance, you lose interest only on the days after your withdrawal. With monthly average balance, the withdrawal reduces your average for the entire month. With lowest balance, you lose interest on the full month. Check your account terms to see which method your bank uses.

Is there a minimum balance I need to earn interest?

Some accounts require a minimum balance to earn any interest at all, while others have no minimum. Some pay a higher rate if you maintain a higher balance. Check your account disclosure or contact your bank to see what applies to your account.