An interest-bearing account, also known as a deposit account, is a type of bank account that pays interest on the funds deposited into it. These accounts come in various forms, including savings accounts, checking accounts, money market accounts, and certificates of deposit (CDs).
How does an interest-bearing account work?
An interest-bearing account allows the account holder to deposit money into a bank account. In return, the bank pays interest on the balance in the account. The interest rate, which is the percentage of the deposit amount paid as interest, varies depending on the type of account and the financial institution.
The purpose of an interest-bearing account is to help individuals and businesses save money and earn a return on their deposits. These accounts provide a safe and convenient way to grow one’s savings over time, while also providing easy access to the funds in case they are needed.
Additionally, interest-bearing accounts can also serve as a way to save for a specific goal, such as a down payment on a house or a child’s education.
Types of Interest-Bearing Accounts
Savings Accounts
A savings account is a type of deposit account that allows account holders to save money and earn interest on their deposits.
How they work
To open a savings account, you typically need to deposit a minimum amount. Then, you can make additional deposits and withdrawals as needed. The bank pays interest on the account balance at a set rate, which is usually lower than other types of deposit accounts.
Pros and cons
Savings accounts offer a safe and easy way to save money. They often have few fees and easy access to funds. However, the interest rates on savings accounts tend to be lower than other types of deposit accounts, such as a CD or money market account.
Ready to get started? Here are the best savings accounts of 2023.
Checking Accounts
A checking account is a type of deposit account that is typically used for everyday transactions, such as paying bills or making purchases.
How they work
Checking accounts allow account holders to deposit money, withdraw funds, and write checks. Interest may be paid on the account balance, although the interest rate is typically lower than savings accounts.
Pros and cons
Checking accounts offer convenient access to funds and the ability to write checks. However, they may come with more fees, such as monthly service fees or check-writing fees.
Ready to move forward? Here are the best checking accounts of 2023.
Money Market Accounts
A money market account is a type of deposit account that typically offers a higher interest rate than a savings account. However, it usually comes with higher minimum deposit and balance requirements.
How they work
A money market account allows account holders to make limited transactions, such as deposits and withdrawals, and write checks. The bank pays interest on the account balance at a higher rate than savings accounts.
Pros and cons
Money market accounts offer higher interest rates than savings accounts and often have check-writing capabilities. However, they typically require a higher minimum deposit and balance to avoid fees.
Check out the best money market accounts of 2023.
Certificates of Deposit (CDs)
A certificate of deposit (CD) is a type of deposit account that typically offers a higher interest rate than savings or checking accounts, but with a fixed term of deposit.
How they work
To open a CD, you typically need to deposit a minimum amount and agree to leave the funds in the account for a set period of time, known as the term of the CD. The bank pays interest on the account balance at a higher rate than savings accounts. However, the account holder is not able to withdraw the funds before the end of the term without penalty.
Pros and cons
CDs offer higher interest rates than savings or checking accounts, and they can be a good way to save for a specific goal with a set time horizon. However, account holders are not able to access their funds before the end of the term without penalty. This can be a disadvantage if the funds are needed earlier.
How Interest is Calculated
What is an interest rate?
Interest rate is the percentage of the deposit amount paid as interest by the bank or credit union to the account holder. It’s typically expressed as a percentage of the deposit amount and is usually stated as an annual percentage rate (APR).
For example, if an account has an interest rate of 1% per year and you deposit $100 into the account, the account holder would earn $1 in interest after one year.
What is compound interest?
Compound interest is when interest is earned not only on the original deposit, but also on the accumulated interest over time. It’s a powerful tool to help savings grow over time.
Compound interest can be calculated daily, monthly, or annually, depending on the bank’s policies. The more frequently interest is compounded, the faster the savings will grow.
What is annual percentage yield (APY)?
Annual percentage yield, or APY, is the rate at which an account holder earns interest on an account. It takes into account the frequency of compounding. It’s a more accurate measure of the true return on an account than the interest rate alone because it factors in how often the interest is compounded.
For example, if an account has an interest rate of 1% per year and compounds interest annually, the APY would be 1%. However, if the interest is compounded more frequently, such as monthly, the APY would be higher than 1%.
Factors That Affect Interest Rates
Interest rates are affected by a variety of factors, including economic and financial institution factors.
Economic Factors
- Inflation: As the cost of goods and services increases, the interest rate will typically increase as well to offset the rising costs.
- Federal Reserve policy: The Federal Reserve sets monetary policy, which includes setting the target for the federal funds rate. When the federal funds rate changes, it can affect interest rates on other types of accounts.
- Gross domestic product (GDP): The overall health of the economy, as measured by GDP, can also impact interest rates. A strong economy may lead to higher interest rates as demand for loans increases.
Financial Institution Factors
- Asset and liability management: Banks and credit unions use a variety of methods to manage their assets and liabilities. These methods can impact the interest rates they offer on deposit accounts.
- Capital and reserve requirements: Banks are required to hold a certain amount of capital and reserves, and this can affect the interest rates they offer.
- Market competition: The level of competition in the market can also affect interest rates. In a highly competitive market, banks and credit unions may raise rates on interest-bearing accounts to attract customers.
Keep in mind that interest rates on interest-bearing accounts are constantly changing and subject to various factors. Be sure to stay informed about current economic and banking trends that can affect the interest rate on your account.
It’s also a wise idea to regularly shop around and compare rates to make sure you’re getting the best rate on your account.
Interest-Bearing Accounts FAQs
What is a high-yield savings account?
A high-yield savings account is a type of savings account that offers a higher interest rate than a traditional savings account. As the name suggests, these savings accounts are designed to provide a higher yield or return on the money you deposit into them. This means that you earn more interest on your savings over time, which can help your money grow faster.
What is a high-yield checking account?
A high-yield checking account is a type of checking account that offers a higher interest rate on the balance in the account than a traditional checking account. These checking accounts are designed for people who regularly keep a high balance in their checking account and are looking to earn a little extra money on that balance.
What is the best interest-bearing account?
Online banks are often able to offer the best rates on checking, savings, money market, and CDs due to their lower overhead costs.
These banks don’t have the same expenses as traditional banks. This allows them to pass on the savings to customers through higher interest rates.
What are the fees associated with interest-bearing accounts?
Interest-bearing accounts may have fees associated with them, such as monthly maintenance fees, withdrawal fees, and transfer fees. Some bank accounts may also have minimum balance requirements or charge fees for failing to maintain a certain balance.
Additionally, there may be fees associated with closing an account or for account inactivity. Be sure to review the fees associated with an interest-bearing account before opening one so that the account will be cost-effective for your needs.
Source: crediful.com