How Does An Interest Bearing Account Work?

How does an interest bearing account work

If you’re trying to get your finances in order, one of the first things you will need to do is set up a savings account. There are numerous benefits to having a savings account, from making sure you have an emergency fund for unexpected expenses, to saving up for a downpayment on a house.

Regardless of your reasons for saving, one of the best ways to save is with an interest-bearing account. Instead of putting your money under your mattress, let your cash multiply by putting it into an account that gives you interest.

What is an interest bearing account?

An interest-bearing account is an account that gives you interest for the money you have deposited. You basically get paid to keep your money in one place.

Why, you might ask? That’s because when you deposit money into a high-interest account, the bank uses that money to either make investments or offer loans to other clients. A portion of that revenue is then given to you in exchange.

How is the interest calculated on an interest-bearing account?

Interest rates vary depending on the account where you put your money. In a savings account, it is based on compound interest, where the principal and all accumulated interest are taken into account. This interest is usually calculated using the annual percentage yield (APY). This is how much money your account earns in one year, including compound interest.

How much you earn depends on what type of account you have. You will earn different rates if the account is compounded. Compounding means the interest on your initial deposit, plus any interest you’ve already earned. It can be compounded daily, monthly, quarterly, or even annually.

If your account just offers simple interest, then you will just earn a set percentage of money invested on the account each year.

Similarly, your account will get a different return if you have a fixed or variable rate. And of course, your total return will vary by how much you have in your account, to begin with.

Different types of interest-bearing accounts

If you want to put your money into an interest-bearing account, there are a number of things to consider.

Do you want to deposit a lump sum or contribute to the account every month? How often do you want to withdraw funds?

Below are outlined three of the most popular accounts where you can earn interest.

1. High yield checking or savings account

This account works the same as a typical checking or savings account but gives you higher interest than you might get from a traditional bank.

These types of accounts are best for short-term goals. You can put as much as you want in these accounts. But keep in mind that the APY rate can change, so you’re not always guaranteed the same rate later on.

2. Money market account

If you want to deposit a large amount of cash and won’t need access to your savings for a while, then a money market deposit account might be a good choice. These types of accounts have less flexibility than a typical checking account but often have much higher interest rates.

You will normally have to deposit a significant amount of money to open a money market account. So this option is best if you already have a bit of money saved up. You also may be charged a fee if you go below the required minimum deposit.

3. Certificate of deposit

Also known as a CD, a certificate of deposit generally has the highest interest rate. However, you generally have to keep your money in your account for a much longer period of time in order to get the higher interest rate. And during this time you won’t be able to take out the funds.

Just like with a money market account, you will have to deposit a certain amount into the CD. The initial deposit can vary, from $200 to as much as $10,000. You can have a CD for as short as a few months, to a few years. This is a good option for longer-term planning.

Associated fees to keep in mind

When you open up an interest-bearing account, there may be a number of fees that are charged. Make sure you look these up ahead of time so you don’t get any unpleasant surprises when you check your monthly balance or try to withdraw funds.

Maintenance fees

Some accounts will charge a monthly or yearly fee to maintain the account and keep it open.

Account minimum fees

You could be charged if you don't maintain a certain amount in your account.

Withdrawal fees

If you try to withdraw the funds, you could be charged a certain amount or receive penalties, depending on the account.

The benefits of interest-bearing accounts

There are a number of reasons you should open an interest-bearing account. Not only will you earn money on saving your cash, but you can keep it in a place where you won’t be tempted to spend it.

It’s always a good idea to save money and keeping one or even several accounts that earn you interest is an even better idea.

Just getting started with your finances and want to save some cash with an online bank? Have longer-term goals in mind and want to open a CD? Interest-bearing accounts can be the secret to make your money grow!

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