What Does Interest Bearing Account Mean?
Learn how your deposited money can earn income over time. This guide explains interest-bearing accounts, how they work, and what to consider for smarter savings.
Understanding How Interest Accrues
An interest rate is the percentage a financial institution pays an account holder for holding funds, typically expressed as an annual percentage. Interest earned depends on this rate and the account’s balance.
Interest often earns interest itself, a concept known as compounding. Compounding frequency impacts total earnings; more frequent compounding (daily, monthly, quarterly, or annually) generally leads to higher returns as previously earned interest begins to earn interest sooner.
Financial institutions calculate interest based on the account’s average daily or ending daily balance, applying the stated rate. This interest is added to the principal, increasing the total balance, which then becomes the basis for future calculations.
Common Types of Accounts That Earn Interest
Savings accounts are interest-bearing accounts for accumulating funds. They typically offer a modest interest rate and provide a secure place for money not immediately needed. While they generally limit monthly withdrawals or transfers, they still allow access to funds.
Money Market Accounts (MMAs) often provide higher interest rates than standard savings accounts. They combine features of savings and checking accounts, allowing limited checks or debit card transactions. MMAs usually require a higher minimum balance to open and maintain.
Certificates of Deposit (CDs) offer a fixed interest rate for a predetermined term, from a few months to several years. Funds are typically locked in until maturity; early withdrawals usually incur a penalty. CDs suit funds not needed for a specific duration, providing predictable returns.
Some checking accounts earn interest on the deposited balance. These accounts may have requirements like maintaining a minimum balance, setting up direct deposits, or making a certain number of debit card transactions. Interest rates are generally lower than savings accounts or CDs.
Important Considerations When Choosing an Account
When selecting an interest-bearing account, compare the Annual Percentage Yield (APY) rather than just the simple interest rate. APY reflects the actual annual rate of return, including compounding effects, allowing for a more accurate comparison of earning potential.
Fees can reduce or negate interest earned. These include monthly maintenance charges, excessive transaction fees, or charges for falling below a minimum balance. Understanding the fee structure is important.
Many interest-bearing accounts require a minimum balance to earn interest or avoid monthly service charges. Failing to maintain this balance can lead to forfeiture of interest or fees. Confirm these requirements to align with your financial habits.
Access to funds, or liquidity, varies among interest-bearing accounts. Savings and money market accounts generally offer reasonable liquidity, while Certificates of Deposit restrict access for a set term. Evaluate how readily funds can be accessed without penalty. Deposits at federally insured banks are protected by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 per depositor, per insured bank, for each account ownership category. Credit union deposits are protected by the National Credit Union Administration (NCUA) with the same coverage limits.