So what is interest? Put simply, it’s the cost of borrowing something. In this case, money. So depending on who’s doing the lending and who’s doing the borrowing … you may be earning interest or paying interest.

When you deposit your cash into a bank, they pay you interest for borrowing your money. All banks tell you the interest rate you’ll earn as an “Annual Percentage Yield,” or APY.

This rate matters, even for products like savings accounts… because rates can vary significantly across banks. Some savings account interest rates are as low as one-hundredth of a percent, while others are as high as one percent.

So say you had a five-thousand dollar balance in your account. The difference between a hundredth of a percent and one percent is fifty cents in interest versus fifty dollars and twenty three cents, over the course of a year.

But, how do banks calculate this interest?

Let’s assume you keep that same five thousand dollars in your savings account and the bank pays one percent APY. At the end of the first month you would earn four dollars and seventeen cents in interest, which is then added to the balance of your savings account. You continue to earn interest on your balance… and as your balance grows each month, so does your monthly interest. This is called compounding interest. At the end of the year, if you add up all your monthly interest payments, you will have earned fifty dollars and twenty-three cents in interest.

To learn about how much you could earn in interest with a savings account, click here.

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