Interest is money the bank pays you for holding your balance with them

When you deposit money into a savings account, the bank lends that money to other customers and businesses. In exchange, the bank pays you interest — a percentage of your balance, calculated and added to your account on a schedule set by the bank. The amount you earn depends on three things: how much money you have in the account, the interest rate the bank offers, and how often the bank compounds the interest (adds earned interest back into your balance so it earns interest too).

The interest rate varies widely. A bank might offer 0.01% annual percentage yield (APY) on a basic savings account, while an online bank might offer 4.5% or higher on the same type of account. The difference between these two rates means that $10,000 earning 0.01% generates about $1 per year, while $10,000 at 4.5% generates about $450 per year. The bank sets the rate based on what the Federal Reserve charges them to borrow money, competition with other banks, and how much they want to attract deposits.

Interest compounds, meaning you earn interest on your interest. If your account compounds daily, the bank divides your annual rate by 365, calculates interest on your current balance, and adds it back when ready. The next day, interest is calculated on the slightly larger balance. Over a year, this compounding effect adds up — the more frequently interest compounds, the more you earn.

Key Takeaways

  • Interest rates on savings accounts range from near zero at traditional banks to 4% or higher at online banks, and the rate you receive depends on the bank you choose, not on your account balance.
  • Interest compounds on a schedule — daily, monthly, or quarterly — meaning you earn interest on previously earned interest, and daily compounding generates slightly more than monthly compounding on the same rate.
  • Your total interest earned is calculated as: (balance × annual rate ÷ number of compounding periods per year) × number of periods, and you can find this calculation on your monthly statement.
  • Moving your money to a higher-rate account costs nothing and takes one to three business days, so comparing rates across banks before opening an account is the single largest factor in how much you earn.
  • Interest is taxable income, and the bank will send you a 1099-INT form at the end of the year if you earned $10 or more in interest.

How the interest rate is set and why it changes

Banks do not set interest rates arbitrarily. The Federal Reserve sets a federal funds rate — the interest rate at which banks lend money to each other overnight. When the Fed raises this rate, banks' costs go up, and they typically raise the rates they offer on savings accounts. When the Fed lowers the rate, banks usually lower savings rates too. This is why your savings account rate might change several times a year, even if you do nothing.

Competition also drives rates. When one online bank raises its savings rate to 4.5%, other online banks often follow within weeks to avoid losing deposits. Traditional brick-and-mortar banks, which have higher operating costs, typically offer lower rates than online banks because they cannot compete on rate alone — they rely on branch access and customer relationships.

The bank's own strategy matters too. A bank that wants to grow deposits quickly might offer a high introductory rate for three months, then drop it. A bank that is not actively seeking new deposits might keep rates low. Reading the terms before you open an account tells you whether the rate is may provide for a year, subject to change, or an introductory offer.

The difference between APY and APR on savings accounts

Banks advertise savings rates using APY (annual percentage yield), not APR. APY includes the effect of compounding — it shows you the actual percentage of your balance you will earn in a year if you leave the money untouched. APR (annual percentage rate) does not include compounding and is used mainly for loans and credit cards.

If a bank advertises 4.5% APY and compounds daily, that 4.5% already accounts for the fact that you will earn interest on your interest throughout the year. A bank that compounds monthly at the same 4.5% APY will generate slightly less total interest than one that compounds daily, because daily compounding gives your money more opportunities to earn. The difference is small — on $10,000 at 4.5%, daily compounding earns roughly $5 to $10 more per year than monthly compounding — but it adds up over time.

Always compare banks using APY, not the stated rate. The APY is what you will actually receive.

Where to find accounts with higher interest rates

Online banks consistently offer higher rates than traditional banks because they have no physical branches and lower overhead costs. Banks like Marcus, Ally, and American Express Personal Savings regularly offer rates between 4% and 5%, while a typical Chase or Bank of America savings account offers 0.01% to 0.05%. The trade-off is that you cannot walk into a branch — you manage your account entirely online or by phone.

Credit unions sometimes offer competitive rates, especially if you are a member. Check your local credit union's website or call to ask what they offer on savings accounts. Credit unions are member-owned, not shareholder-owned, so they sometimes return profits to members through higher rates.

Money market accounts, which are a hybrid between savings and checking accounts, often pay slightly higher rates than savings accounts at the same bank. However, they usually require a higher minimum balance and limit how many withdrawals you can make per month. High-yield savings accounts are straightforward savings accounts with higher rates — the name just means the bank is paying more than average.

Certificates of deposit (CDs) pay higher rates than savings accounts, but your money is locked in for a set period — three months, one year, five years. If you withdraw early, you pay a penalty. CDs make sense only if you know you will not need the money during the term.

How to move your savings to a higher-rate account

Opening a new savings account at a higher-rate bank takes 10 to 15 minutes online. You will need your Social Security number, a government ID, your current address, and your employment information. The bank will verify your identity and run a soft credit check (which does not affect your credit score).

Once your account is open, transfer your money from your old bank. You can do this by providing your new bank with your old bank's routing number and your old account number, and requesting an incoming transfer. This takes one to three business days. Alternatively, you can withdraw cash from your old bank and deposit it into your new bank, though this is slower and riskier.

You do not have to close your old account when ready. Many people keep a small balance in their old bank for direct deposit or bill payments while moving most savings to the higher-rate account. Once you have confirmed the transfer went through and you no longer need the old account, you can close it by calling the bank or visiting a branch.

What happens to interest if you withdraw money mid-month

Interest is calculated on your balance at specific points in the month, depending on the bank's method. Some banks use the average daily balance method: they add up your balance for each day of the month and divide by the number of days. Others use the ending balance method: they calculate interest only on what you have on the last day of the month. A few use the beginning balance method, which is rare and unfavorable to you.

If you withdraw $5,000 on the 15th of the month and your bank uses average daily balance, you lose interest on that $5,000 for only half the month. If your bank uses ending balance, you lose interest on the full $5,000 for the entire month. Check your account terms or call the bank to find out which method they use. Most online banks use average daily balance, which is more favorable.

Interest is usually posted to your account monthly, though some banks post it daily or quarterly. When it posts, it becomes part of your balance and starts earning interest itself. You can see the exact amount posted on your monthly statement.

Interest earned is taxable income

The interest your savings account earns is taxable as ordinary income. If you earn $10 or more in a calendar year, the bank will send you a Form 1099-INT by January 31 of the following year. You report this on your tax return, and you owe federal income tax on it (and state income tax in most states).

If you earn less than $10, the bank does not send a form, but you are still required to report the interest on your tax return. Keep your monthly statements so you can add up the total if needed.

The tax you owe depends on your overall income and tax bracket. If you earn $500 in interest and you are in the 22% tax bracket, you owe roughly $110 in federal tax on that interest. This is why the difference between a 0.01% account and a 4.5% account matters — the higher rate means more interest, but also more taxes owed.

Frequently Asked Questions

Can I earn interest on a checking account?

Some checking accounts pay interest, but the rates are almost always lower than savings accounts — typically 0.01% to 0.5%. Most people keep their checking account at a bank for convenience and their savings at a higher-rate bank. A few online banks offer checking accounts with rates competitive with savings accounts, but these usually require a minimum balance or direct deposit.

What is the highest interest rate I can find on a savings account right now?

Rates change frequently based on Federal Reserve decisions and bank competition. As of early 2024, online banks offer rates between 4% and 5.35%, but this varies by bank and changes monthly. Check current rates on comparison websites or directly on bank websites — the rate advertised is the rate you will receive when you open an account.

Does keeping more money in my account earn me a higher interest rate?

No. The interest rate is the same whether you have $100 or $100,000 in the account. You earn more total interest with a larger balance because the percentage is applied to a bigger number, but the rate itself does not change. Some banks offer tiered rates where higher balances earn slightly higher rates, but this is uncommon and the difference is usually small.

What happens to my interest if the bank fails?

Your deposits are insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per account type per bank. If the bank fails, the FDIC pays you your balance plus all accrued interest up to the limit. This protection applies to savings accounts, checking accounts, and money market accounts. Credit union deposits are insured by the National Credit Union Administration (NCUA) with the same $250,000 limit.

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

Yes. Interest is calculated through the last day of the month (or whenever your bank posts it), so if you transfer your money on the 20th, you receive interest for the full month at your old bank. Your new bank starts earning interest on the day the transfer arrives. There is no gap or loss.