A deposit account — such as a savings account or interest-bearing checking account — can be an attractive place to park your cash. It’s safe, allows relatively quick access, and even helps you earn a little bit of money, thanks to what’s known as the deposit interest rate.
The deposit interest rate is the amount of interest that a bank or other financial institution will pay you when you make a deposit. (You may also hear it referred to by such terms as simply the interest rate or the APY, for annual percentage yield.) Understanding deposit interest rates can help you choose among banking products and find the one that best suits your needs.
To help you with that knowledge, we’ll dive into the topic here and explore:
• What is a deposit interest rate in banking?
• How does a deposit interest rate work, and how is it calculated?
• What kinds of deposit interest rate accounts are there?
What Is a Deposit Interest Rate?
When you put money into a deposit account, your bank or financial institution will pay you interest. Why? Banks use a portion of the money that’s deposited with them to make loans to other customers, perhaps as a mortgage, business loan, or personal loan.
The bank pays you interest for the privilege of lending out your money. They will then charge a higher interest rate on the loans they make, which is how the bank turns a profit.
Incidentally, just because a bank is loaning out your money doesn’t mean your cash won’t be there when you need it. Banks typically carry a cash reserve to cover withdrawals their customers need to make.
How Does a Deposit Interest Rate Work?
Deposit interest rates in banking are expressed as percentages. The amount of interest you earn will be based on how much cash you’ve deposited in your account, also known as your principal.
The interest rate you’re offered will vary by account. For example, a simple savings account may offer a relatively low interest rate, while a high-yield savings account or a money market account may offer a higher rate.
Your interest rate will also be determined in part by the federal funds rate. That rate is the amount the Federal Reserve suggests banks charge to lend each other money overnight.
Recommended: How Does a High Yield Savings Account Work?
How Is Deposit Interest Rate Calculated?
Wondering how interest rates are calculated? It usually is done in one of two ways: as simple interest or compounding interest.
Simple interest is a matter of multiplying the principal by the interest rate. As the name suggests, it is easier to calculate. However, most banks will use compounding to calculate interest rates. Compounding interest essentially allows you to earn a return on your returns, which can help your money grow exponentially. So your principal earns interest, and that amount of interest is added to the principal. Then the interest rate gets calculated again at a certain interval based on that pumped-up principal. This keeps happening, helping your savings grow. Interest can compound at various rates, such as continuously, monthly, or annually, depending on the product and financial institution.
Ways Deposit Interest Rates Are Applied by Institutions
Financial institutions can apply interest rates in a variety of ways. First, they can be fixed or variable. A fixed interest rate guarantees that you will receive an interest payment equal to a certain percentage of your principal. This percentage won’t change over the life of the account. So if your interest rate on your money is set at, say, 2%, that is what you will get, period.
A variable interest rate, on the other hand, may change according to shifts in a benchmark interest rate, such as the federal funds rate. As the benchmark rises, so too will the interest rate. What if the benchmark drops? That means you’re paid less interest.
Additionally, some deposit accounts will offer higher interest rates for larger balances. A certificate of deposit, or CD, may offer you better interest rates if you agree to park your cash in the account for a longer term.
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Real-Life Example of Deposit Interest Rate
Let’s take a look at how to do the math on a couple of examples of deposit interest rates. If you’re a bank customer with $10,000 to deposit, here are two scenarios:
• Bank 1 is a bricks-and-mortar bank offering 0.01% interest. (Remember, one percentage point is one-hundredth of a whole.) If you deposit your $10,000 for one year, you’ll earn: 10,000 x 0.0001 = 1. At the end of 365 days, you will have the principal plus the interest, or $10,001.
• Bank 2 is an online bank offering 1.0% interest. If you deposit the same $10,000 for a year, you’ll earn: 10,000 x 0.01 = 100. You’ll have $10,100 at year’s end.
Types of Deposit Interest Rate Accounts
There are a variety of different deposit account types that you might encounter. Here are four of which you should be aware. We’ll explain how each one works.
1. Savings Accounts
Savings accounts are designed specifically as a place for you to put cash you might need in the short-term. For example, you might keep your emergency fund in a savings account, since you’d need quick access to cash if your car’s transmission failed or you had to cover an unexpected medical bill.
Not only does your savings account allow you to earn interest, it is also one of the safest places you can put your money. That’s because the Federal Deposit Insurance Corporation (FDIC) guarantees your money, up to $250,000, as it does with the deposit accounts below. That means in the rare case that your bank fails, you will still have access to your money.
You can deposit cash at an ATM, in person, or through mobile deposits. You can deposit checks or cash into the account, too. When you make a deposit, your funds may not be immediately available for use. Check with your bank to understand their rules around fund availability.
2. Interest-Bearing Checking Accounts
Many checking accounts have very low fees and don’t pay interest. As a result, it doesn’t make sense to keep a lot of money in this type of account. In fact, you may want to keep just enough to pay your bills.
Interest-bearing checking accounts are an exception. They allow you to collect interest on your account, which could be a nice perk. After all, you may well have your paycheck deposited there by setting up direct deposit, which can make your funds available quickly. Whatever remains in your account after paying your bills could be earning you some interest.
However, these accounts may be more complicated and expensive, with higher fees and minimum balance requirements. It’s important to make sure that the expense of holding the account doesn’t outweigh the interest paid.
3. Certificates of Deposit
A certificate of deposit, or CD, is a product offered by financial institutions that offers a higher interest rate if you agree to keep your funds in place for a period of time. Typically, the length of time is from six months to a few years, but it could be anywhere from one month to 20 years. The longer the period, the higher the interest rate you will probably be offered.
Here’s the rub: If you find that you need the money in the CD before the account matures (meaning the agreed-to time period passes), you’ll likely have to pay early withdrawal penalties. That said, it is possible to get CD’s with no-penalties, but you may have to compromise, such as by accepting lower interest rates.
4. Money Market Accounts
Money market accounts, on the other hand, pay interest and allow for withdrawals. They often pay higher interest rates than traditional savings accounts. However, in return, these accounts may require you to make higher initial deposits and they may have minimum balances, which could be $10,000 or more.
Like checking accounts, money market accounts can offer checks and debit cards, though they may limit the number of transactions you may make per month.
The Takeaway
There are a number of different deposit accounts that offer a deposit interest rate, ranging from checking and savings accounts to CDs and money market accounts. The interest rates will likely vary. For example, with CDs, the rates may depend on factors such as account minimums or term of deposit. Understanding these kinds of “fine print” differences will help you find the right match for your needs, whether your goal is the highest possible interest or having enhanced access to your funds.
If you’re in the market for accounts with a super-competitive interest rate, come check out what SoFi offers. Our online bank accounts, when opened with direct deposit, offer a competitive APY, no-fees, automated savings, and more great perks.
FAQ
Do you get interest when you deposit money?
When you deposit money in an interest-bearing deposit account, you will start to earn interest. In other words, your money makes money.
Which deposits pay more interest?
The amount of interest you earn will depend on your interest rate and the amount of money in the account. The more money you deposit and the higher the interest rate, the more interest you will earn. Also, online banks typically pay interest rates than bricks-and-mortar banks.
Do all banks have deposit interest rates?
Banks that offer interest-bearing deposit accounts will always offer a deposit interest rate.
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SoFi members with direct deposit can earn up to 4.20% annual percentage yield (APY) interest on Savings account balances (including Vaults) and up to 1.20% APY on Checking account balances. There is no minimum direct deposit amount required to qualify for these rates. Members without direct deposit will earn 1.20% APY on all account balances in Checking and Savings (including Vaults). Interest rates are variable and subject to change at any time. These rates are current as of 4/25/2023. There is no minimum balance requirement. Additional information can be found at http://www.sofi.com/legal/banking-rate-sheet.
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