A perk of having a savings account is the monthly interest that gets credited to your account. While the interest payments by banks motivate the general public to save more, it also helps them plan their finances in a better way. Knowing how much interest amount will be credited to your bank account each month allows you to reconcile your closing balances without worry. The fact that the bank genuinely pays you to deposit a sum of money is an inducing factor for choosing a savings account.
Generally, saving accounts receive interest payments based on compound interest. However, some banks also provide interest on a simple interest method for making fixed payments. In this article, we will learn all the methods to calculate these interest payments. So, read on to end your confusion on how to calculate interest on a savings account once and for all!
Defining Savings Account Interest
The interest is any amount you pay or receive on your principal amount. If you lend a sum of money to a bank by depositing, you will be entitled to receive an interest payment. While seeking a loan, the bank or lender may charge some amount of interest from you.
A savings account interest falls under the former situation where you will receive a sum of interest for your money deposited with a bank or financial institution. It is counted as the bank’s initiative to promote more savings and maintain its cash flow. But, before knowing how to calculate interest on a savings account, you must be aware of the types of interest payments made by banks.
Types of Saving Account Interest
Savings account interest payments come in two forms – simple interest and compound interest. Most banks pay compound interest on the amount in the savings account. However, the same is calculated using the principal amount from the simple interest method. Both methods of calculating interest are stated below:
- Simple Interest: It is the interest that you earn on the principal balance of your savings account. In simple words, it is the interest that is calculated on the total value of your deposits. In such an interest calculation model, the interest remains fixed and never grows with time.
- Compound Interest: It is the interest earned on both the initial principal amount and the accumulated interest from previous periods. Unlike simple interest, which is calculated only on the principal, compound interest takes into account the growing balance over time.
How to Calculate Interest Earned on a Savings Account?
Having a fair knowledge of the amount of interest (that you are entitled to receive) is easier and more convenient with services like online interest calculators and comprehensive e-bank statements. However, if you still want to acknowledge yourself with the manual calculation, then the following formulas may help.
Simple Interest = P x R x N
Here, P is the principal amount/ beginning balance
R is the rate of interest (generally converted in decimals)
N is the number of the time period for calculation
Let’s say you deposited INR 10,000 at the rate of 1.5% per annum in your bank. Your interest calculation for the year will be like this:
Applying the formula – P x R x N
10,000 x 0.015 x 1 = 150 (interest earned for the year)
The formula for compound interest for the same scenario is provided below.
[10,000 (1+0.015)^1]- 10,000 = 150 (interest earned for the year)
Compound Interest = [P (1 + R)^N] – P
Let’s calculate the compound interest for the next three years:
Compound Interest = [10,000 (1 + 0.015)^1] – 10,000 = 150 rupees (INR)
Principal (P) = 10,000 + 150 (previous year’s interest)
Compound Interest = [10,150 (1 + 0.015)^1] – 10,150 = 152.25 rupees (INR)
Principal (P) = 10,150 + 152.25 (previous year’s interest)
Compound Interest = [10,302.25 (1 + 0.015)^1] – 10,302.25 = 154.53 rupees (INR)
Therefore, the compound interest earned for the next three years would be 150 rupees (INR) in the first year, followed by 152.25 rupees (INR) in the second year and 154.53 rupees (INR) in the third year. Financial institutions usually pay interest on your savings using the compound interest method.
Check Out: Compound Interest Calculator Online
Must-know Facts About Savings Account Interest
Now that you know the formula to calculate interest on a savings account, you must always keep yourself updated about your interest amount and other regulations. Here are some important points about savings account interest that you must keep in mind:
- Banks usually credit the accumulated interest on a quarterly or semi-annual basis.
- The compounding effect takes place every quarter, as the interest earned from the previous quarter is added to the account balance.
- Different types of savings accounts result in varying interest rates. With premium or high-yield savings accounts, the banks typically offer higher rates.
- Maintaining higher balances in your savings account often leads to an increase in the interest rate you earn.
A savings account provides interest payments daily, monthly, quarterly, or annually based on your bank account type. The calculation of these interest payments often confuses people. The above article addressed the question of how to calculate interest on a savings account. With the methods mentioned above, one can easily calculate his/her earned interest income. Between both methods, compound interest is used by financial institutions to increase the earnings of customers over time.