The basic formula: multiply your balance by the rate and the time
Interest earned on a savings account comes from multiplying three things: the money you have in the account, the annual interest rate the bank pays, and how long that money sits there. The simplest version is Interest = Balance × Annual Rate × Time in Years. If you keep $1,000 in an account paying 4% APY for one full year, you earn $40. If you keep it there for six months (0.5 years), you earn $20.
Most banks use this method for basic calculations, but the real picture is more complex because banks compound interest — they add earned interest back into your account and then pay interest on that new total. That compounding happens daily, monthly, or quarterly depending on the bank, and it means you earn slightly more than the simple formula suggests.
Key Takeaways
- Simple interest uses the formula Balance × Annual Rate × Time, but most savings accounts use compound interest instead, which pays interest on your interest.
- Daily compounding (the most common method) calculates interest each day on your current balance, then adds it back to your account.
- The APY (Annual Percentage Yield) already includes the effect of compounding, so you can compare accounts fairly without doing extra math.
- Your bank statement or online account shows interest posted, but you can verify the math by checking the daily rate and the number of days interest accrued.
How compound interest actually works in your account
When a bank compounds interest daily — which most savings accounts do — it divides the annual rate by 365 to get a daily rate, then applies that rate to your balance each day. On day one, if you have $1,000 at 4% APY, the bank calculates $1,000 × (0.04 ÷ 365) = about $0.11 in interest. That $0.11 gets added to your balance, so on day two you earn interest on $1,000.11. This happens every single day.
Over a month, this daily compounding adds up. After 30 days at 4% APY on $1,000, you have roughly $1,003.29 instead of $1,003.29 — the extra pennies come from earning interest on the interest. After a full year, daily compounding at 4% APY turns $1,000 into $1,040.81, not exactly $1,040, because of those compounding gains.
The bank does not show you this daily calculation on your statement. Instead, it posts the total interest earned once a month or once a quarter. You see the lump sum added to your account, but the work happened invisibly every day behind the scenes.
Why APY is the number that matters for comparison
Banks publish the APY (Annual Percentage Yield) specifically so you do not have to do compound interest math yourself. The APY already includes the effect of daily compounding. If a bank says an account pays 4% APY, that means if you leave $1,000 untouched for a year, you will have $1,040 at the end — the compounding is already baked in.
This is why you should always compare banks using APY, not the interest rate alone. Two banks might advertise different rates, but if one compounds daily and the other compounds monthly, the APY tells you which one actually pays more. The APY is the honest number.
Calculating interest when you add or withdraw money
The math gets messier if your balance changes during the month. Most banks track your balance on each day and calculate interest based on the average daily balance or the daily balance method. With the daily balance method, the bank calculates interest each day on whatever you have in the account that day, then sums it all up at the end of the month.
For example: if you start the month with $1,000, deposit $500 on day 15, and keep it there until day 30, the bank calculates interest on $1,000 for 14 days, then on $1,500 for 16 days. The total interest is the sum of those two periods. You do not need to do this math — your bank does it — but knowing how it works explains why your interest varies month to month.
Withdrawals work the same way. If you pull out $500 on day 20, the bank stops earning interest on that $500 from that day forward. The interest you see posted reflects only the days and balances you actually held.
Reading your bank statement to verify the math
Your bank statement or online account shows interest posted monthly or quarterly. To spot-check the calculation, you need three pieces of information: the daily rate, the number of days interest accrued, and your average balance. The daily rate is the APY divided by 365. If your account shows 4% APY, the daily rate is 0.04 ÷ 365 = 0.000109589.
Multiply that daily rate by your average balance and by the number of days in the period. If your average balance was $1,000 over 30 days, the math is $1,000 × 0.000109589 × 30 = about $3.29. That should roughly match what your bank posted (it may be off by a cent or two due to rounding). If it is off by more than a few cents, contact your bank.
Most banks also show the daily rate somewhere in your account settings or in the fine print of your account agreement. If you cannot find it, call and ask — they are required to tell you.
The difference between stated rate and APY
Some banks list both a "stated rate" and an "APY." The stated rate is the raw interest rate before compounding. The APY is what you actually earn after compounding happens. For savings accounts, the APY is always slightly higher than the stated rate because of compounding, but the difference is usually small — a few basis points (hundredths of a percent).
For example, a bank might advertise 3.99% stated rate with 4.07% APY. The difference comes from daily compounding. When you are shopping for accounts, use the APY to compare, because that is the real return you get.
What happens to interest if you close the account early
Interest accrues up to the day you close the account. If you close on the 15th of the month, you earn interest for 14 or 15 days (depending on how the bank counts), and that interest is posted to your account before the closure is final. You receive that interest as part of your final withdrawal.
Some accounts have penalties for early withdrawal, but those usually apply only to money market accounts or certificates of deposit (CDs), not regular savings accounts. A regular savings account lets you withdraw anytime without penalty, though you stop earning interest on money once it leaves the account.
Frequently Asked Questions
How often does interest get added to my account?
Most banks calculate interest daily but post it monthly or quarterly. You see the lump sum appear in your account once a month or once every three months, but the bank has been earning it for you every single day. Check your account agreement to see your bank's posting schedule.
If I have $5,000 at 5% APY, how much do I earn in a year?
Roughly $250, though the exact amount depends on daily compounding. The simple math is $5,000 × 0.05 = $250, but with daily compounding you earn a few dollars more. Your bank will show the exact amount when it posts interest.
Does my interest get taxed?
Yes. Interest earned on savings accounts is taxable income. Your bank sends you a 1099-INT form at the end of the year if you earned $10 or more in interest. You report this on your tax return. The interest is taxed at your ordinary income tax rate, not as capital gains.
Can I lose money if interest rates drop?
No. Interest rates dropping means new accounts will pay less going forward, but the money already in your account stays safe. You will not earn as much interest on new deposits, but existing balances do not shrink. Your principal is always protected in a savings account.
What if my bank compounds monthly instead of daily?
You earn slightly less interest than with daily compounding, but the APY accounts for this difference. If two banks both advertise 4% APY, you earn the same amount over a year regardless of whether one compounds daily and the other compounds monthly. The APY makes them equivalent.