What is an interest-bearing account?
Key takeaways
- Interest-bearing accounts can help you save for an emergency, vacation or other goals while giving you a return.
- The amount of interest you earn depends on the type of account you open.
- Each type of account has benefits and drawbacks, which are worth considering before you decide which one to open.
Your money can make money. When you deposit your cash into an interest-bearing account, you earn a return based on your account balance and the interest rate available. A few accounts earn interest, and each one has different features. Before you open an account and make a deposit, review your options.
What is an interest-bearing account?
Interest is what a borrower pays when they take out a loan. It's the cost of borrowing money. When you open an interest-bearing account at a bank, you're giving the bank permission to loan your money to other customers. As a result, you get some of the interest those borrowers pay.
Banks set interest rates based on the market and other factors. Some banks offer higher rates than others on similar types of accounts.
How much interest an account earns depends on a few factors, including how long you leave the money in the account and how much you deposit. Often, the longer you leave the money untouched, the higher the interest on the account. Many banks also increase the interest rate on an account when people make larger deposits. More money for them to use can mean more money for your account to earn.
How does an interest-bearing account work?
Typically, an interest-bearing account pays interest monthly. The interest rate may fluctuate based on the market or the bank. Interest is paid as a percentage of your balance, so the amount you earn depends on the size of your bank balance. An account with a balance of $5,000 will earn more interest than an account with $50 even if the interest rate is the same.
The amount of interest your account can earn is called the annual percentage yield, also known as APY. APY refers to the total percentage your account earns and how frequently that interest compounds. Interest may be compounded daily, monthly or quarterly.
Say you open a savings account with a 3.00% APY. The account compounds daily, and you deposit $500 into it. After one year, if you don't make any additional deposits to your account, you'll have $515.23.
How does compounding interest work?
Wait a second, 3.00% of $500 is $15, so where did that extra 23 cents come from? That's compound interest or having the interest on your account earn interest. If your account compounds interest, and most do, your money works even harder for you because the interest also starts to yield a return.
Tip: Pay attention to fees when shopping for an interest-bearing account. Some bank accounts charge a monthly maintenance fee, which can easily eat up all the interest you earn.
The different types of interest-bearing accounts
If you're looking to open an interest-bearing account, you have options.
Savings accounts
A savings account is a basic interest-bearing account. You open the account and make a deposit, and the bank pays you interest. You may not get the highest rate on a basic savings account since the money in the account is liquid, meaning that you can access it almost as quickly as cash at any time.
Money market accounts
Money market accounts typically pay higher interest rates than standard savings accounts but usually have higher minimum balance requirements. You also may have a limited number of withdrawals you can make from the account.
Certificates of deposit (CDs)
When you open a CD account, 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 get a higher interest rate than you would on a savings account. If you need your money sooner, you typically need to pay an early withdrawal penalty, which is often calculated as a few months of interest.
Interest-bearing checking accounts
Some checking accounts pay interest. Since money is meant to flow in and out of a checking account with ease, these accounts tend to have low interest rates. Think of interest as a nice-to-have feature, but don't let that be the only feature you consider when choosing a checking account.
What type of interest-bearing account should I choose?
The account that's right for you depends on a few factors, and you could have several types of bank accounts at the same time. When picking a deposit account, weigh the pros and cons of each based on your needs and financial goals.
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Money market account |
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CD |
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Interest checking account |
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Where can I find an interest-bearing account?
Most banks offer at least one type of interest-bearing account, and many offer multiple options, including multiple savings accounts. You can find interest-bearing accounts at brick-and-mortar and online banks.
When you're looking to open a bank account, find one that offers the best interest rate and terms that work for you. For example, if you're just starting, you may not want to open an account that requires a $5,000 minimum balance. You may also want to keep your money fairly liquid rather than locking it away in a CD, even if that CD earns a high interest rate.
APY is also a big factor to consider when looking for an account, as it directly impacts the interest your money will earn during the year.
Interest-bearing account FAQs
What are the advantages of interest-bearing accounts?
Interest-bearing accounts are a secure way to help your money grow.
Are interest-bearing accounts FDIC-insured?
Savings accounts, money market accounts, checking accounts and CD accounts at banks are all insured by the Federal Deposit Insurance Corporation, up to $250,000 per depositor per bank. If something happens to your bank, you can be confident your money is safe.
Do you pay taxes on interest-bearing accounts?
You pay federal income taxes on any interest your account earns. You may have to pay state income tax, too, depending on where you live.
Why do banks pay interest on savings accounts?
Banks use the money in interest-bearing accounts to make loans. They earn interest on the loans and offer a portion of it to you.
When is interest paid out?
Many accounts pay interest monthly, but some, such as 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. Some may have an APY under 1.00%, while others have an APY of 2.00%, 3.00%, 4.00% or higher.
Growing your savings with interest
If you're looking for a safe way to save your money and watch it grow, opening an interest-bearing account can be a good option. The amount you can earn depends on the account type and your balance, but no matter what, opening an account can be a great way to start saving.
Want to learn more about interest-bearing accounts and how to open one? Explore the money market accounts and savings accounts from Citizens today.
Related topics
How many bank accounts do you need?
Rather than choosing just one bank account, you could open multiple. But how many do you need?
Money market accounts vs. savings accounts
Money market accounts and savings accounts both earn interest, but they have some key differences.
CD vs. savings account
CDs usually offer higher interest rates than savings accounts, but they restrict access to your savings.
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Disclaimer: The information contained herein is for informational purposes only as a service to the public, and is not legal advice or a substitute for legal counsel. You should do your own research and/or contact your own legal or tax advisor for assistance with questions you may have on the information contained herein.