What Is a Deposit Interest Rate?

Deposit Interest Rate Explained

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A deposit interest rate is the rate at which you earn money from a bank or financial institution on your deposits in an interest-bearing account. The actual deposit interest rate amount is based on a percentage of the principal balance.

Learning what a deposit interest rate is and how it can impact your savings can be a crucial step toward reaching your financial goals.

Definition and Example of Deposit Interest Rate

A deposit interest rate is the percentage of profit you earn on your money in an interest-bearing account with a financial institution. It’s essentially the money banks and credit unions pay you for keeping your money in their institutions.

  • Alternate names: interest rate, annual percentage yield (APY), rate of return

When you think of interest rates, you probably think of them as the fees you pay for borrowing money. However, with the deposit interest rate, you also have the opportunity to earn money.

How much money you will earn is based on a percentage of the principal balance in your account. The deposit interest rate is typically quoted as an annual percentage yield (APY).  You can compare APYs of different financial institutions to find the most competitive rates to earn more on your money.

Use an APY to calculate the money you will earn over the course of a year. It includes the interest rate on the principal balance and the compounding interest.

Knowing the deposit interest rate or APY on your accounts can play a role in helping you reach your savings goals because rates can vary significantly across banks. For example, Chase offers a 0.01% APY on a savings account, while CIT Bank pays a 0.50% APY.

How Deposit Interest Rates Work

When you deposit money into an interest-bearing account, the bank either uses it to lend money and earn interest on those loans, or the bank may invest those funds to earn money.

Banks pay you a certain percentage to encourage you to deposit with them so they can use your money to make their own money.

The deposit interest rate is what a bank pays you for keeping your funds on deposit. You’ll typically find higher interest rates with savings accounts than with checking accounts.

For example, if you deposited $3,000 in a bank like CIT Bank, which pays 0.50% APY on deposits in its savings accounts, you would earn $15 in the first year. The formula would look like this:

$3,000 x 0.05% (0.005) = $15

As another example, let’s say Bank A is paying 0.01% APY to their savings-account customers, and Bank B is paying 1.00% APY. If you had a $5,000 balance in your account, you would earn approximately 50 cents after one year with Bank A versus $50 with Bank B.

A few factors determine the deposit interest rate. The federal funds rate, set by the Federal Reserve, is a primary driving factor in determining the interest rates a bank pays.

When the Fed raises interest rates, the interest on your savings account interest rates may increase as well. Similarly, if the Fed lowered its benchmark interest rate, the interest on your savings account will most likely drop.

Other factors that determine the deposit interest rate include the demand by investors for U.S. Treasury notes and bonds, the banking industry itself, and its level of desire to attract new deposits.

In general, online banks typically offer much higher interest rates than their brick-and-mortar counterparts because online institutions don’t have to pay as much overhead, such as they would with lease payments if they had physical locations. So online banks can pass on savings from their operational costs to customers in the form of higher interest rates.

The Truth in Savings Act (TISA) requires banks to disclose interest rates, fees, minimum balance requirements, and any other terms, limitations, and changes to their deposit accounts.

Types of Deposit Interest Rate Accounts

There are more than just saving accounts that offer deposit interest rates, although savings accounts may be the most well known.

Savings Accounts

These accounts are designed for you to keep money aside for long-term goals while earning interest. The deposit interest rates are generally higher than on checking accounts, but they may not be as high as other investment options, such as bonds.

CDs

CDs are known as “time deposit” accounts, a specific type of savings account. You must keep your funds deposited, or you could face penalties and lose some or all of your interest. CD time frames could be from three months to five years or more, and they typically offer higher interest rates than traditional savings accounts.

Interest-Bearing Checking Accounts

Some checking accounts may offer interest on deposits, but typically not as high as a savings account. Checking accounts are designed to allow you to access your money for daily use, whereas savings accounts often limit the number of transactions you can make in a month.

Money Market Accounts (MMA)

MMAs are another savings vehicle that pays interest on your deposit. They often require a higher minimum balance, but offer higher interest rates than traditional savings accounts. Unlike with CDs, you can withdraw your money at any time without penalty.

According to the Expedited Funds Availability Act, money deposited into an interest-bearing account begins accruing interest on the first business day that the financial institution receives provisional credit for the funds.

Types of Deposit Interest Rates Methods

The deposit interest rate you earn is typically paid by your bank or credit union to your account monthly, based on your principal balance. However, financial institutions calculate interest daily using one of the following two methods:

  • Average daily balance method: This is when a periodic rate is applied to the average daily balance in your account during a statement period. The average daily balance is calculated by adding the total principal balance in the account for each day of the period and dividing that amount by the number of days in the period.
  • Daily balance method: This is when the daily periodic rate is applied to the total amount of principal in the account each day.

How To Get a Deposit Interest Rate

To begin earning money from a deposit interest rate, simply open an interest-bearing account. Here are a few easy steps to open an account:

  • Choose a bank or credit union by comparing rates
  • Choose the type of interest-bearing account that suits your needs
  • Gather your identification documents such as an ID, Social Security card, or birth certificate
  • Open the account in person or online if the option is available
  • Add money to the account

Is the Deposit Interest Rate Worth It?

When you’re saving money, an interest-bearing account can help you earn more toward your financial goals. Compare deposit interest rates from different banks, because higher interest rates means you earn more money.

With savings accounts, you can take advantage of the power of compound interest. That means the interest you earn is added to your principal balance, which in turn creates a larger principal amount for future interest payments. Your financial institution will let you know if your interest compounds daily, monthly, quarterly, or some other specified amount of time.

The more frequently your interest compounds, the faster your earnings will grow.

Key Takeaways

  • A deposit interest rate is the rate of return a financial institution pays you on your deposits into its account.
  • Interest rates can vary by financial institution, and a higher interest rate means you will earn more money.
  • Interest-bearing accounts can include savings accounts, CDs, money market accounts, and high-interest checking accounts.