How to Calculate Interest
When you are searching for banking options, learning how to calculate interest is critical. Understanding the money you can earn upon deposit can help you decide which bank and account are right for you. Learn more about how to calculate interest on a savings account with Public Service Credit Union below, and check out our blog for more financial tips.
What is Interest on a Savings Account?
So, what is interest? Interest is essentially the cost of borrowing money. When you look to borrow money to buy that new home in Romulus, you will have to pay interest on the amount you borrowed. You can think of interest as a fee for using someone else’s money. When you deposit money into your Redford bank, they are technically borrowing your money, so they will pay you interest in return.
There are online calculators that can crunch the numbers for you, but learning how to calculate interest and more importantly, how to make sense of those figures, is the best way to plan your financial future.
How Are Interest Rates Set?
You may be wondering how banks set interest rates to begin with. Interest rates at individual banks are tied to the rate the U.S central bank is charging to member banks, also known as the Federal Reserve Discount Rate. If the central bank raises interest rates, the domino effect will lead to individual banks following suit.
Conversely, when the central bank is attempting to stimulate the economy, interest rates may be lowered with the same trickle-down effect. Now that you know what interest rates are and how they are set, you will want to learn more about how to calculate interest on a checking or savings account.
How to Calculate Interest on a Savings Account: Simple vs. Compound
Calculating Simple Interest
While uncommon, understanding how to calculate simple interest is still beneficial. In this scenario, you will need to find out the APY (annual percentage yield) from your bank. If your account uses simple interest, you will earn interest year over year only on your initial deposit.
Say you deposit $10,000 into an account with an APY of 1%. In one year, you will have earned $100 in interest ($10,000 x 0.01 x 1). After two years, you will earn $200 in interest ($10,000 x 0.01 x 2). The longer you leave your money in the account, the more money you will earn. However, it is important to keep in mind that you will only gain interest based on the original deposit amount, regardless of how much money is in the account.
Calculating Compound interest
Calculating interest on an account with compounding interest is much more common. Rather than using the APY, a compound interest rate will determine the yield from the account. Compounding interest is a powerful tool because interest is calculated based on the initial deposit plus any previously earned interest. Banks will often make interest payments on a monthly or quarterly basis. The more frequent the interest payments, the more money you will earn.
The formula for calculating compounded interest is ((P*(1+i)^n) - P), P stands for the principal (original deposit), i represents the annual interest rate, and n displays the number of periods. If you deposit that same $10,000 into an account that compounds interest at 1% and pays out monthly, after 1 year you will have earned $100.46. After 2 years, you will have earned $201.93. While this may not seem like much of a boost, interest rates are usually paid out at a higher percentage than 1%, and the cumulative effect of keeping your money in an account long term can be quite substantial.
Turn to Public Service Credit Union for Financial Guidance
Still looking for guidance on how to calculate interest on a savings account? The team here at Public Service Credit Union can provide key insight into all of your financial queries. From how to calculate interest on a checking account to guidance to help you set up a savings account for your kids, we can walk with you through every step of your financial journey. We offer tons of online resources so all of our Detroit customers can confidently meet their financial goals. Contact us to learn more about how we can serve you.