The financial advice we’re all given from a young age? Save money.
Depositing cash into a savings account can be a savvy move because it allows you to set aside money for larger purchases, like your dream vacation, a down payment, or to help prepare for unexpected expenses. Plus, the interest earned on the account helps you build on your savings without any added effort. What are the different types of interest and how do they work? Let’s dive in.
Read more: How Ally Bank’s buckets and boosters make saving easier
What is interest on a savings account?
When you deposit your money in a savings account, the bank pays you interest for keeping those funds in the account. The more you deposit, the more interest you can earn. Your interest earnings also increase the longer you leave the funds deposited in your savings account.
Almost all savings accounts earn interest, but rates can vary significantly, usually between 1-5%, depending on the type of deposit account. At Ally Bank, for example, our high-yield Savings Account earns more than five times the national average Annual Percentage Yield, or APY.
Simple vs. compounding interest
You can earn two types of interest on your savings: simple or compound.
What to know | Simple interest | Compound interest |
|---|---|---|
What it is | Interest earned only on the original principal deposit | Interest earned on both the original principal deposit and the accumulated interest |
When it’s used | Common for certain basic, older or specific promotional savings products; less common for modern high-yield savings accounts | Common for high-yield savings accounts and Certificates of Deposit (CDs) |
Growth characteristics | Interest remains constant, growing at a steady, predictable pace | Grows faster over time, accelerating long-term savings growth |
How to calculate interest in a savings account
To determine how much savings interest you will earn, you want to pay attention to the annual percentage yield (APY). This is the rate of interest earned on a deposit over a year factoring in compounding. And yes, the higher your APY, the better.
This table breaks it down:
The breakdown | Simple interest | Compound interest |
|---|---|---|
How it’s calculated | Principal × interest rate × time | Uses the interest rate and the number of compounding periods. Interest for the period is added to the principal and the future interest is calculated on the new total. |
Example | $1,000 at 5% simple interest for one year earns $50; total $1,050. Over five years (no additional deposits), total grows to $1,250. | $1,000 at 5% APY compounded daily earns about $51.27 in one year; total ~$1,051.27. Over five years (no additional deposits), total grows to ~$1,284. |
While interest is often accrued daily, it is generally added to your savings account once at the end of each monthly statement cycle.
DIY: 4 questions to calculate your compound interest
It’s easy to calculate simple interest. Compound interest can multiply daily, weekly, monthly or quarterly (depending on the bank and specific account type), so it can be more complicated to determine. Answer these four questions to calculate your interest:
Help maximize how much interest you earn
Want to see your savings grow faster?
Choose a savings account with a high interest rate
Choose a savings account with interest that compounds daily
Choose a savings account with no monthly fees
Set a deposit schedule and commit to it
Use a savings account to reach your goals
Remember, the more you save, the faster your savings grows. It all starts with opening the right account and regularly depositing funds. Once you achieve your savings goals, treat yourself and enjoy the peace of mind knowing that you’re one step closer to your financial goals.
