How do savings accounts earn interest?

Trying to understand how interest works on savings accounts? If the answer is yes, then you’re in the right place. 

Many people have a general idea of what interest is, but they’re more familiar with the other type of interest — the one that banks charge on loans. But customers also receive interest from banks or other financial institutions on the money in their savings account. The more funds you have, the more interest you’ll earn. 

Here, we’ll dive into how interest on savings accounts works, what impacts interest rates, and how to calculate your potential interest earnings on a deposit amount. Let’s go! 

In short, interest is the cost of a financial transaction. If you’re the borrower — for example, you take out a loan from a bank — then interest is the fee that you pay. 

However, if you’re the lender — as in, you’re putting money into a financial product like an easy-access savings account — then interest is the fee that you collect. Interest payments act as a kind of reward from the bank for holding your money with them, allowing them to loan it out and earn interest themselves. It’s calculated as a percentage of your deposit amount and is paid out monthly, quarterly, bi-yearly, or yearly. 

Another term for this is deposit interest, although it’s usually just referred to as interest.

Interest rates depend on a variety of factors, from politics to bank policies and competition in the finance sector. Percentages can fluctuate tremendously. Here’s a table of the rate changes every five years going back to 1980.

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In principle, you can assume that your bank's deposit interest rates will rise if general market interest rates rise, which in turn depend on the central bank’s key interest rate. However, this doesn’t always happen to the same extent — it depends on the competitive situation and the demand for loans. In times of low interest rates, savers often receive very low interest on their deposits, which can lead to reduced purchasing power.

It’s nearly impossible to predict how interest rates will develop. In Europe, banks decide on their interest rate in relation to the European Central Bank’s key interest rate. In October 2023, the ECB decided against a further interest rate increase. This may mean that interest rates for banks will slow down or level off for a while.

Interest is money paid to you in exchange for holding your funds with a financial institution. There are a variety of account types that will pay you interest:

• Savings accounts or passbooks 
• Term-deposit accounts
• Easy-access or money market savings accounts
• Credit cards

Whether you’re planning to open a savings account for the long term, or a money market account to stay more flexible, one thing’s clear: The more money you deposit, the higher your returns will be. That’s because as soon as you begin earning interest, you’ll earn interest on the interest you’ve earned — this is known as compound interest.

In rare cases, banks offer interest on checking account balances. However, even if you find an offer like this, the interest rates will likely be low in comparison to other savings products. Given this, it’s probably more worthwhile to explore other interest-bearing accounts like fixed-term deposit accounts or easy-access savings accounts. 

As of November 2023, banks in Germany are offering between 0.1% and 4% for easy-access deposit accounts (also called a money market account, or Tagesgeldkonto in German). This type of account has two major advantages: you’ll earn a competitive interest rate, and you can access your funds whenever you need them. 

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Many financial institutions have products that pay interest on customer deposits, so it’s important to do your research to get the best rates. Here are some kinds of financial institutions that offer interest-bearing accounts:

• Traditional banks
• Online banks 
• Credit card companies 
• Building and housing collectives (Bausparverträge in German)

The interest rate you earn on your deposit can vary quite a bit between banks. As a general rule, traditional banks offer lower interest rates. Online banks can sometimes offer higher interest rates because their business model allows them to save money on other costs — and pass the savings onto their customers by way of interest.

How much interest you’ll earn on your money in real terms depends on a variety of factors, from your deposit amount to the amount of time the money is invested. The good news? It’s not as complex as you might think. 

You can use a tool like our interest calculator to figure out your future interest earnings in minutes. Simply enter your deposit amount, interest rate, and investment timeframe and that’s it — you’re all set to start earning. 

This is the most basic type of calculation, and it doesn’t factor in the additional interest earned on capital gains. Here’s the formula:

I = D×r×t

Here’s a breakdown of what this means:

• I = the total interest amount
• D = your deposit amount
• r = interest rate per period (in decimal form — for example, 5% is represented as 0.05) 
• t = time period

So, the interest you’ll earn is your deposit amount multiplied by the interest rate, then further multiplied by the time period that you leave your money in the account.

One more thing to note: There’s a difference between nominal interest and effective yearly interest, which also takes into account fees and capital gains taxes.

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