How Do Savings Interest Rates Work?

Defining Savings Interest Rates

Savings interest rates provide a modest return on a low risk investment. It is as simple as going down to your local bank or savings and loan, depositing some money into a savings account and waiting for interest to accumulate over time. Since the FDIC insures bank deposits up to $100,000.00 per person per financial institution, there is very little chance you could ever lose your investment. However, savings interest rates tend to be low. Often they are below the rate of inflation.

Improving Savings Interest Rates

When you open a savings account, the interest rates are disclosed. This could be a fixed amount that does not change over a term like a certificate of deposit or variable adjusting in relations to the prime interest rate like a money market account. Since interest rates are always a percentage of the deposit, the more you have in the account the more money you will make in interest. Likewise, the higher the interest rate the greater the return. Often you can negotiate higher savings interest rates by depositing more money in a financial institution. Banks and savings and loans regularly give better savings interest rates to their best customers.

Annualizing Savings Interest Rates

It is important to understand that savings interest rates are annualized. That means they are stated as the interest rate that would be paid over the course of one year. Savings interest rates are stated this way regardless of the frequency interest is paid.

Savings Interest Rates Payments

Interest payments are paid periodically on savings accounts. This happens regardless of whether the interest rate is fixed or variable. How often interest is paid depends on the frequency of compounding. This can be every day, week, month or year. Interest payments are usually reinvested into the savings account but they can also be paid separately to the account owner.

Savings Interest Rates Yields

As a result of compound interest, the amount paid on a savings account will exceed the savings interest rate for the account. This happens because every time interest is paid the size of the account grows. The next time interest is calculated it is on a slightly larger amount. This is why most financial institutions also list the account "yield" along side the interest rate. The yield is what the account actually pays.

Influences on Savings Interest Rates

Savings interest rates are pegged to the prime interest rate designated by the Federal Reserve Bank. When it is expensive to borrow money, savings interest rates are high so that financial institutions can raise funds to make loans. When the Federal Reserve Bank sets the prime interest rate low, savings interest rates are also low.