The Basic Formula for Savings Account Interest

Interest on a savings account is calculated using one of two methods: simple interest or compound interest. Most savings accounts use compound interest, which means you earn interest on your initial deposit plus all the interest that has already accumulated.

The formula for compound interest is: A = P(1 + r/n)^(nt), where A is your final amount, P is your principal (starting balance), r is the annual interest rate as a decimal, n is how many times interest compounds per year, and t is the number of years. For simple interest—used less often—the formula is: I = P × r × t, which gives you only the interest earned, not the total balance.

Your bank's website or account statement will tell you which method they use and how often they compound (daily, monthly, or quarterly). Most online banks compound daily, which means your interest grows faster than with monthly or quarterly compounding.

Key Takeaways

  • Compound interest earns you money on your money—you get interest on your principal and on previously earned interest combined.
  • The annual percentage yield (APY) already accounts for compounding, so you can compare rates directly between banks without doing extra math.
  • Daily compounding grows your balance faster than monthly or quarterly compounding, even at the same interest rate.
  • Your bank statement or online dashboard shows your current balance and interest earned; you do not need to calculate it yourself for basic tracking.
  • If you want to project future balance or compare banks, use your bank's calculator or a free online compound interest tool rather than doing the math by hand.

Why APY Matters More Than the Interest Rate

Banks list two numbers: the interest rate (also called the APR) and the annual percentage yield (APY). The APY is the number you should use to compare accounts, because it already includes the effect of compounding.

For example, two banks might both advertise a 4.5% interest rate, but if one compounds daily and the other compounds monthly, the daily-compounding account will grow slightly faster. The APY for the daily account might be 4.60%, while the monthly account's APY might be 4.59%. That difference looks tiny, but over years it adds up. The APY does the compounding math for you, so you can compare banks without pulling out a calculator.

Your bank is required to show you the APY in the account disclosure or on the rate page. If you see only an interest rate and no APY, ask the bank for the APY before opening the account.

How to Use Your Bank's Tools Instead of Calculating by Hand

Most banks provide a compound interest calculator on their website, usually near the savings account rates page. You enter your starting balance, the APY, how long you plan to keep the money in the account, and the calculator shows your projected balance. This is faster and more accurate than doing the math yourself, and it accounts for the specific compounding schedule your bank uses.

Your online banking dashboard also shows your current balance and the interest you have earned so far in the current month or year. You do not need to calculate this—the bank does it for you and updates it daily or monthly depending on their system. If you want to verify the number, you can check your monthly statement, which lists the opening balance, interest earned, and closing balance.

If your bank does not have a calculator, free tools like Bankrate's compound interest calculator or the Federal Reserve's savings calculator let you enter your details and see the projected growth. These tools work for any bank's rates and compounding schedules.

The Difference Between Daily, Monthly, and Quarterly Compounding

Compounding frequency affects how fast your balance grows. With daily compounding, the bank calculates interest on your balance every day and adds it to your account. The next day, you earn interest on that new, slightly higher balance. This happens 365 times per year, so the effect compounds quickly.

Monthly compounding does the same calculation only 12 times per year, and quarterly compounding only 4 times. At the same interest rate, daily compounding produces more total interest than monthly, which produces more than quarterly. The difference is small in the first few months but becomes noticeable over years.

Here is a concrete example: $10,000 at 4.5% APY compounded daily grows to $10,460 after one year. The same $10,000 at 4.5% compounded monthly grows to $10,459. The daily account earns $1 more in this case, but over 10 years the gap widens. Most online banks use daily compounding, while some traditional banks use monthly or quarterly.

What Happens When You Deposit or Withdraw Money

Interest is calculated on your average daily balance or your ending balance, depending on the bank. If your bank uses average daily balance, they add up your balance for each day of the month and divide by the number of days. If they use ending balance, they calculate interest only on what you have in the account on the last day of the month.

When you deposit money, it starts earning interest immediately (or the next business day, depending on when the deposit clears). When you withdraw money, you stop earning interest on that amount. If you withdraw before interest is credited to your account, you lose the interest you would have earned on that money for that period.

Some accounts have withdrawal limits or penalties if you withdraw too often. Check your account terms to see whether withdrawals affect your interest rate or trigger fees. High-yield savings accounts typically allow six withdrawals per month without penalty, though this rule varies by bank.

How Interest Rates Change and What That Means for Your Balance

Banks change their interest rates based on what the Federal Reserve does with its benchmark rate. When the Fed raises rates, banks usually raise savings account rates within days or weeks. When the Fed lowers rates, banks lower savings account rates, often more slowly. Your existing balance continues to earn interest at the new rate once the change takes effect.

You do not need to do anything when a rate changes—your bank updates the rate in your account automatically. Your next interest payment will be calculated at the new rate. If you want to lock in a higher rate before it drops, some banks offer certificates of deposit (CDs), which may provide a fixed rate for a set period (three months to five years, typically). A regular savings account rate can change at any time.

If your bank lowers rates and you want a higher return, you can move your money to another bank offering better rates. There is no penalty for closing a savings account and opening one elsewhere, though you may lose any promotional bonus the original bank offered.

Frequently Asked Questions

Do I need to report savings account interest on my taxes?

Yes. If you earn $10 or more in interest in a calendar year, your bank sends you a Form 1099-INT, and you must report that interest as income on your tax return. The interest is taxed as ordinary income at your regular tax rate. Keep your year-end statement or the 1099-INT form for your records.

Why does my bank statement show less interest than I calculated?

The most common reason is that you used the annual rate but the interest was only credited for part of the year, or your balance changed during the month. Interest is calculated on your actual balance for the actual number of days it was in the account. If you deposited money mid-month, you earn interest only on that amount from the deposit date forward, not for the full month.

What is the difference between APR and APY?

APR is the annual interest rate without compounding factored in. APY includes the effect of compounding, so it is always equal to or higher than the APR. When comparing savings accounts, use APY, because it shows the real return you will get.

Can I earn interest on interest?

Yes, that is what compound interest is. Each time interest is credited to your account, the next interest calculation includes that new amount. Over time, this creates a snowball effect where your balance grows faster and faster, even if the interest rate stays the same.

What happens to my interest if I close the account?

Interest earned up to the day you close the account is yours to keep. The bank pays it out as part of your final balance. Interest accrued but not yet credited may or may not be paid, depending on the bank's policy—ask before you close the account if you want to be sure.