How to calculate interest on your savings account

Savings account interest rates have been on the rise in Canada this year, with some of the best accounts offering APYs between 4% and 6%. The Bank of Canada has raised its federal interest rate several times over the past year to tamp down on surging inflation, and recently decided to hold rates steady.

While this means savings account interest rates might not go any higher this month, they’re also not expected to drop anytime soon. If you’re not earning a competitive interest rate on your savings, you could be leaving hundreds to thousands in interest on the table.

Here’s what you need to know about earning interest on your savings.

What is Interest on a Savings Account?

A savings account is a type of deposit account that’s separate from your primary chequing account. It allows you to set aside money for different savings goals, like creating an emergency fund for unplanned expenses or growing your down payment on a future home. Many banks offer interest on their savings accounts as an incentive for you to keep your money with that bank.

Savings interest is a percentage you earn on the money you keep in a savings account. Banks compound this interest on a set schedule, so you’ll earn interest on your original balance, then you’ll earn interest on your balance plus any previous interest. Assuming the savings rates are the same, you’ll earn slightly more interest at a bank that compounds daily or monthly than a bank that compounds annually.

While some traditional big bank savings accounts may offer less than 1% annual percentage yield (APY) on your savings, many banks in Canada have raised rates along with the central bank, with some of the most competitive accounts offering more than 6% APY on your savings.

How Do You Calculate Interest on a Savings Account?

The formula for calculating simple interest is as follows:

P x R x T = Interest Earned

P = principal, or your beginning balance

R = interest rate (annual percentage yield)

T = time period

For example, if you have $5,000 in a savings account and you earn 5% interest in a high-yield savings account all year, here’s the formula for calculating how much interest you’ll have at the end of the year:$5,000 (principal) x 0.05 (rate) x 1 (time; one year) = $250.

You would earn $250 in that one year, assuming your savings interest rate remains the same and your bank compounds your interest annually.

What Types of Interest Can be Calculated?

If your bank compounds your interest monthly or quarterly, you’ll earn slightly more than you would if it compounded your interest annually.

For example, using the same example above, if you earn 5% on your $5,000 in savings, but the bank compounds your interest monthly, you’d earn $255.81 at the end of the year. Likewise, if your bank compounds your interest quarterly, you’d earn $254.73.

The reason you earn more with compound interest is because your bank calculates and pays out your interest more often. This increases your balance, so the next time your interest is compounded, the first round of interest will be included in the calculation.

While the difference in what you’ll earn if your bank compounds your interest monthly versus annually in this example isn’t huge — it’s just under $6 — if you have tens of thousands in a savings account, you can earn much more with a bank that compounds your interest monthly.

What Rates Are Currently Trending?

On October, 25, 2023, the Canadian central bank chose to hold rates steady, keeping the overnight rate — the rate at which Canadian banks lend to one another — at 5%. The bank rate is set at 5.25% and the deposit rate is at 5%.

Whenever the central bank raises rates — as it’s done several times throughout 2022 and 2023, banks typically follow suit, increasing the interest rates on consumer products like loans, credit cards, and savings accounts. That means the cost of borrowing goes up, but the amount you can earn on your savings also increases.

Right now, many Canadian banks are offering savings accounts at 4.5% or above, with some even topping 6%. It’s possible the Bank of Canada may see fit to raise rates again if inflation doesn’t continue cooling. But even if the central bank holds rates steady at its next few meetings, experts predict high savings rates will stick around through early 2024.

That makes right now a great time to earn extra interest on money in your deposit accounts.