Interest rates on savings accounts depend on the bank, the account type, and the current federal rate — you earn more at online banks than at brick-and-mortar branches, and rates change when the Federal Reserve moves.

A savings account earns interest when the bank pays you a percentage of your balance in return for holding your money there. The amount you earn is calculated as an annual percentage yield, or APY. If your account has an APY of 4.5%, a $10,000 balance earns roughly $450 per year, though the bank usually deposits interest monthly or daily in smaller pieces.

The APY your bank offers depends on three things: how much money you have in the account, what type of account it is, and what the Federal Reserve's current interest rate is. When the Fed raises rates, banks typically raise APYs within weeks. When the Fed cuts rates, banks cut APYs just as fast. Online banks almost always pay higher rates than traditional banks because they have lower overhead costs.

Key Takeaways

  • Online banks typically pay 4% to 5% APY on savings accounts, while traditional banks often pay 0.01% to 0.5%, because online banks have lower operating costs.
  • Interest compounds daily or monthly depending on the bank, so money deposited earlier in the month earns slightly more than money deposited later.
  • The Federal Reserve's interest rate directly affects what banks pay you, and changes usually show up in your account within two to four weeks.
  • High-yield savings accounts and money market accounts pay more interest than regular savings accounts at the same bank, but may require a higher opening balance.

How banks calculate and pay interest

Banks calculate interest using your account balance and the APY they advertise. Most banks compound interest daily, meaning they calculate how much you've earned each day and add it to your balance, so the next day's calculation includes yesterday's interest. This compounds over time — you earn interest on your interest.

The actual deposit into your account usually happens monthly. If your bank compounds daily but deposits monthly, you'll see one lump sum hit your account on the same day each month. Some banks deposit interest weekly or quarterly instead. Check your account agreement or call the bank to confirm the deposit schedule, because it affects when you can move the money or use it.

Interest is taxable income. Banks send 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 as ordinary income, which means it's taxed at your regular income tax rate, not as capital gains.

Why online banks pay more than traditional banks

Online banks pay higher APYs because they don't operate physical branches. They have no rent, no tellers, no security costs, and no staff in local offices. That savings gets passed to customers as higher interest rates. A traditional bank with 500 branches nationwide has to cover all that overhead, so they pay less interest to keep their costs down.

Online banks are FDIC-insured just like traditional banks, so your money is protected up to $250,000 per account owner per bank. The trade-off is that you can't walk into a branch to deposit cash or speak to someone face-to-face. Most online banks let you deposit checks by phone camera or transfer money from another bank account, but cash deposits require a trip to a partner location or a traditional bank.

How the Federal Reserve's rate affects what you earn

The Federal Reserve sets a target interest rate that banks use to lend money to each other overnight. This rate, called the federal funds rate, indirectly controls what banks pay on savings accounts. When the Fed raises its rate, banks raise savings account APYs to attract deposits. When the Fed cuts its rate, banks cut APYs to reduce what they pay out.

The lag between a Fed rate change and a change in your account is usually two to four weeks. Some banks move faster than others. Online banks tend to raise rates within days of a Fed increase, but they also cut rates quickly when the Fed cuts. Traditional banks may take longer to raise rates but sometimes hold their rates steady longer when the Fed cuts.

You can track the Fed's current rate on the Federal Reserve's website. The rate is updated after each Federal Open Market Committee meeting, which happens eight times per year. Knowing when meetings are scheduled helps you predict when your bank might change your APY.

Types of accounts that earn higher interest

A regular savings account at an online bank typically pays 4% to 5% APY. A high-yield savings account at the same bank may pay the same rate or slightly higher, but usually requires a higher opening balance — often $25,000 or more. Some banks tiered APYs, meaning you earn a higher rate on balances above a certain threshold.

Money market accounts combine features of savings and checking accounts. They pay interest like a savings account but let you write checks or use a debit card like a checking account. APYs on money market accounts are usually the same as or slightly higher than savings accounts, but the account may have a monthly limit on how many withdrawals you can make.

Certificates of deposit (CDs) lock your money away for a set period — usually three months to five years — in exchange for a may provide APY that's often higher than a savings account. If you withdraw before the term ends, you pay a penalty. CDs are useful if you know you won't need the money for a specific amount of time.

Comparing rates across banks

APYs change constantly, so comparing rates by calling each bank or visiting their websites takes time. Websites like Bankrate, DepositAccounts, and NerdWallet list current rates from dozens of banks and update them daily. You can filter by account type, minimum balance, and whether the bank offers in-person branches.

When comparing, look at the APY, not the interest rate. APY includes the effect of compounding, so it's the true rate you'll earn. Also check the minimum opening balance and any monthly fees. A bank paying 4.75% APY with a $25,000 minimum and a $10 monthly fee may earn you less than a bank paying 4.5% with no minimum and no fees, depending on your balance.

Some banks offer promotional rates for new customers — for example, 5.35% APY for the first three months, then 4.5% after that. Read the fine print to see when the rate drops and whether you have to meet any conditions to keep the promotional rate.

What to do if your bank lowers your rate

Banks can lower your APY at any time, and they're required to notify you before the change takes effect. The notice usually comes by email or mail at least 21 days before the new rate starts. If your bank cuts its rate and you have a large balance, it may be worth moving your money to a bank paying a higher rate.

Switching banks is free and takes a few days. You open an account at the new bank, provide your old account number, and the new bank handles the transfer. Your old bank will close the account once the balance reaches zero. There's no penalty for moving your money between savings accounts, unlike CDs.

If you have a CD and the bank lowers rates, you're locked in at your original rate until the term ends. When the CD matures, you can move the money to a new bank or a new CD at a higher rate. Some banks let you shop around during the maturity period before deciding whether to renew.

Frequently Asked Questions

How much money do I need to open a savings account and start earning interest?

Most online banks let you open an account with $0 to $25. Traditional banks often require $100 to $500. High-yield savings accounts may require $25,000 or more to earn the advertised APY, though some banks let you open with less and earn a lower rate until you reach the threshold.

Can I move my money between banks without losing interest?

Yes. Moving money between savings accounts doesn't trigger any penalty or loss of interest. Interest accrues daily, so you earn interest up to the day you withdraw. The new bank starts paying interest the day your deposit clears, usually within one to three business days.

What happens to my interest if I withdraw money before the month ends?

You still earn interest on the balance you held. If you had $10,000 for 20 days and $5,000 for 10 days, the bank calculates interest on both amounts for the time you held them. Interest is paid monthly, so you'll see the full month's earnings deposited even if you withdrew partway through.

Is my interest protected if the bank fails?

Yes. The FDIC insures savings accounts up to $250,000 per account owner per bank. If a bank fails, the FDIC pays your balance and all accrued interest up to the limit. This protection applies whether you have a regular savings account, high-yield account, or money market account.

Do I have to pay taxes on savings account interest?

Yes. Interest is taxable income. If you earn $10 or more in a calendar year, the bank sends you a 1099-INT form, and you report the interest on your tax return. Interest is taxed at your ordinary income tax rate, which is usually higher than the capital gains rate.