Formula for Calculating Interest Rates in Savings

by Mark Kennan

    Knowing the interest rate on your savings can help you decide whether you should move your money to a different bank in search of a better return. To figure your interest rate on your savings, you need to know how much you have in the account, how much interest you earned, and how long it took you to earn the interest.

    Interest Formula

    To figure the effective periodic interest rate, divide the interest paid by the amount of savings and multiple the result by 100. For example, say your bank paid you $6.25 in interest for the month on $2,500 in your savings account. Divide $6.25 by $2,500 to get 0.0025. Then, multiply by 100 to find that the monthly interest rate on your savings account is 0.25 percent.

    Simple Interest Rate

    To figure the annual simple interest rate for your savings account, multiply the periodic interest rate by the number of periods per year. For example, if the interest rate is 0.25 per month, the annual simple interest rate equals 0.25 percent times 12 months per year, or 3 percent. Annualizing the interest rate makes it easier to compare different accounts.

    Interest Compounding

    Compounding interest refers to how frequently the bank adds the interest that has accrued on your account to your account balance. For example, each day that your money sits in your account, interest accrues on it. However, different banks compound interest at different intervals, so some might add that accrued interest at the end of every day, while other might wait until the end of the month or longer to add it to your account balance. The more frequently interest compounds, the higher the effective annual rate.

    Effective Annual Interest Rate

    To figure the rate you effectively earn on your savings account when you take into account for interest compounding, start by adding 1 to the periodic rate as a decimal. Then, raise the result to the power of the number of times interest compounds each year. Next, subtract 1 from the result. Finally, multiply by 100 to convert to a percentage. For example, if your monthly interest rate is .25 percent, you divide by 100 to convert it back to a decimal: 0.0025. Then you add 1 to get 1.0025. Since interest is compounded 12 times per year, raise 1.0025 to the 12th power to get 1.030415957. Then, subtract 1 from the result to get 0.030415957. Last, multiply the result by 100 to find your effective annual interest rate is just over 3.04 percent.

    About the Author

    Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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