A savings account is a type of account that pays interest on the balance. You can withdraw money from your savings account at any time, but you may be penalized if you make over a certain number of transactions in each month.
The interest rate on savings account is typically the lowest of any other type of investment. But there are some high-yield savings accounts that offer more competitive savings rates.
Savings Account Rates 101
APY vs. Interest Rate
You’ll typically see the savings rate stated as APY or annual percentage yield. The APY helps you understand the amount of interest you’ll really earn on your savings account because it takes into account how often interest is added to your savings account.
If interest is added to your savings account on an annual basis, then the interest rate is enough. You could simply multiply your ending account balance by the interest rate to calculate your interest earnings for that year. For example, if you have $1000 earning a savings rate of 1%, you’d earn $10 in interest at the end of the year.
Simple vs. Compound Interest
If you leave deposits in the savings account long enough, you’ll begin to earn interest on the account. Some banks only pay interest on the amount of money you’ve deposited, not the interest you’ve earned on your account. This is known as simple interest.
Another way banks calculate interest is to add the interest you’ve already earned to the balance you deposited and then calculate your interest earnings on the total amount. This concept where your interest earns interest is known as compound interest.
Compound interest affects the rate of interest you really earn. For example, if your account earns interest every quarter, you would earn a total of $10.04 in interest and the real interest rate would be 1.003756% instead of 1%. It doesn’t make a big difference with small amounts of money, but the more money you have in your savings account, the more that small interest rate adds up.
What balance earns interest?
To make matters more complex, banks have different ways of calculating the balance that interest is applied to. They may use your average daily balance during a certain period. Or, they may choose to charge interest on the minimum balance during the period. Interest could be charged based on the balance at the beginning date or ending date of the period. The ending date’s balance is typically in your best interest.
Understanding Savings Accounts
What are the types of savings accounts?
There are three basic types of savings accounts. A traditional savings account has the lowest interest rate, around 1%. A money market account is a type of savings account that pays a slightly higher rate and allows you to write checks on the balance. Money market accounts have higher minimum balance requirements. Online savings accounts are able to offer higher interest rates than traditional savings accounts because they don’t have the cost of running bank branches.
Are online banks safe?
Your money is safe with an online bank as long as the bank is FDIC-insured. Being FDIC-insured means the federal government will cover your deposit if that bank fails. The FDIC insures accounts up to $250,000. The FDIC-insured amount was previously $100,000 but has been permanently increased as part of the financial reform bill passed under the Obama administration.
Do savings accounts charge fees?
Some banks charge fees on their savings accounts. Others offer the account for free. Of those banks that do charge fees, you may be able to have the fee waived if you maintain a certain minimum balance or make a certain amount of deposits in the year. Accounts with higher minimum balance requirements often pay a higher interest rate than those with lower minimum deposit requirements. You may also have to pay a fee if you exceed a certain number of transactions in a month.