What is an interest-bearing account?

Saving money in a bank account can help with a large purchase, build an emergency fund or get you closer to other financial goals. Depositing funds into an interest-bearing account generates earnings based on your account balance and the current interest rate. Banks offer a range of interest-bearing accounts with distinct features. Before opening a new account and making a deposit, take some time to review your options.

How does an interest-bearing account work?

Interest is what a borrower pays when taking out a loan. It's the cost of borrowing money. When you open an interest-bearing account, you're giving the financial institution permission to loan your money to other customers. As a result, you receive some of the interest those borrowers pay.

The amount of interest you earn depends on a few factors:

• The current prime rate: The federal funds rate can fluctuate depending on the economy and economic indicators.
• How long the money remains in the account: Often, the longer the money is left untouched, the more interest you can earn.
• How much is deposited: Banks may offer higher interest rates for larger deposits, since more money allows them to generate greater returns.

Typically, an interest-bearing account pays interest monthly. Interest is paid as a percentage of your balance, so the amount you earn depends on how much money is in your account. A balance of $5,000 will earn more interest than an account with $50, even if the interest rate is the same.

What is APY on an interest-bearing account?

The amount of interest your account earns is called the annual percentage yield (APY). APY refers to the total percentage your account earns and how frequently that interest compounds. Compound interest is what you earn on your original deposit and the interest it has already earned. Interest may be compounded daily, monthly or quarterly.

For example, you open a savings account with a 3.00% APY that compounds daily and deposit $500 into it. After one year, without any additional deposits to your account, you'll have $515.23.

What are the benefits of an interest-bearing account?

Interest-bearing accounts offer a practical way to grow your money while keeping it accessible. Whether you're saving for short-term goals or simply parking extra cash, these accounts provide several key advantages:

• Passive income growth: You’ll earn interest on your balance as long as you leave money in the account.
• Compound interest: Over time, interest earned can generate additional interest, accelerating growth.
• Liquidity: Although some accounts limit the number of withdrawals you can make per month, funds remain easily accessible, unlike some longer-term investments.
• Low risk: Most financial institutions are insured by the Federal Deposit Insurance Corporation (FDIC), offering added peace of mind.
• No market exposure: Your balance isn't affected by stock market volatility, making it a stable option.
• Encourages saving habits: Seeing regular interest payments can motivate consistent saving.

Types of interest-bearing accounts

If you're looking to open an interest-bearing account, you have several options.

Traditional savings accounts

A savings account is a basic interest-bearing account where you make a deposit and the bank pays you interest over time. Traditional savings accounts usually offer lower interest rates because your money is fully accessible.

Money market accounts

Money market accounts typically pay higher interest rates than standard savings accounts but often require a higher minimum opening deposit. Some money market accounts offer check-writing privileges and allow limited transfers between your checking and savings accounts. However, they usually restrict the number of withdrawals you can make from the account.

Certificates of deposit (CDs)

When you open a certificate of deposit (CD), you're agreeing to let the bank hold on to your money for a set term, such as 12, 24 or 36 months. In exchange, you may receive a higher interest rate than you would on a savings account. If you need your money sooner, an early withdrawal penalty is common, and often calculated as a few months of interest.

Interest-bearing checking accounts

Some checking accounts pay interest, but rates tend to be low because they're meant for frequent access. While earning interest is a nice perk, it shouldn't be your only consideration when choosing a checking account.

What type of interest-bearing account should I choose?

When picking an interest-bearing account, weigh the pros and cons of each based on your needs and financial goals.

What should you consider when opening an interest-bearing account?

Not all interest-bearing accounts are created equally. Before opening a new account, consider the following factors to ensure you can reach your financial goals.

• Minimum balance: Many interest-bearing accounts require a minimum balance to earn interest — or even to avoid fees. Make sure the account fits your financial situation, especially if you're just starting out.
• Interest rate: Banks set interest rates based on market conditions and other factors. If you're looking for a competitive rate and can meet minimum balance requirements, a money market account may offer higher interest than a regular savings account. For everyday savings, an account with a solid rate and few restrictions may be a better fit.
• Account fees: Pay attention to fees when shopping for an interest-bearing account. Some bank accounts charge a monthly maintenance fee, which can easily cancel out the interest you earn.
• Liquidity: How easily can you access your money? Some accounts, like CDs, lock in your funds for a set term. Others, like savings or money market accounts, let you withdraw more freely. Choose based on your short- and long-term needs.
• Convenience: Consider how and where you prefer to bank. Most financial institutions — both brick-and-mortar and online — offer interest-bearing accounts, often with mobile apps, ATM access, direct deposit and automatic transfers. Having your checking and savings at the same bank can also simplify money management.

Interest-bearing account FAQs

What are the advantages of interest-bearing accounts?

Interest-bearing accounts are a secure way to help your money grow. They also offer flexibility, like the easy access of savings accounts and the higher interest rates of CDs for long-term goals.

Are interest-bearing accounts FDIC-insured?

Savings accounts, money market accounts, checking accounts and CDs are all insured by the FDIC, up to $250,000 per depositor, per bank. You can feel confident that your money is safe.

Do you have to pay taxes on an interest-bearing account?

You pay federal income taxes on any interest your account earns. Depending on where you live, you may have to pay state income tax too.

Why do banks pay interest on savings accounts?

Banks make loans with money from interest-bearing accounts. They earn interest on the loans and offer a portion of it to you.

When is interest paid out on savings accounts?

Many accounts pay interest monthly, but some, like CDs, only pay the full amount of interest at maturity or the end of the term.

Do all savings accounts earn interest?

All savings accounts earn interest. However, the amount of interest varies between accounts, ranging from under 1.00% APY to higher than 4.00% APY.

Grow your savings with an interest-bearing account

Opening an interest-bearing account can be a secure and effective way to save your money and watch it grow. Want to learn more about interest-bearing accounts and how to open one? Explore the money market accounts and savings accounts from Citizens today.