How to calculate interest on a savings account

Savings accounts can be a great way to earn interest on your hard-earned money. Not only do they provide a safe place to store your cash (as they are guaranteed under the government’s Financial Claims Scheme), but many offer quick access to your cash if needed.

But how do you know if a savings account is really what you need, as opposed to fixing your rate with a term deposit? The first step is to understand how savings account interest works.

Not a maths whizz? No worries. Use our simple savings calculator to help crunch the numbers.

However, if you want to understand how it works, you’ll need to grasp a few key terms:

• Principal: The initial amount of money you deposit or invest.
• Rate: The percentage of interest that you earn on your principal over a specified period.
• Time: The duration for which your money is invested or saved.

With that in mind, here’s the formula for calculating interest on savings:

Say you’ve saved $6,500 (Principal) and parked it in a savings account with an ongoing interest rate of 2.36% (Rate) and leave it there for 5 years (Time) - your formula would look like this:

If you want to work out how much interest you’ll have made over that period, all you have to do is deduct your initial balance from the new total. In this case, you’ll earn $813.24 interest.

That wasn’t too difficult, but the next step is a little trickier...

If you want to learn how much interest you’ll receive by making regular deposits, the calculations are more complicated. The formula looks like this:

If you’ve been keeping your savings healthy by making regular deposits, the calculations will get a little more complicated. To work out how much interest you’re earning with deposits, the formula looks like this:

Let’s break that down:

Firstly, substitute all your values (P, R & T) into your formula. Using the example above, it would look something like this:

That’s a lot to work with, so simplify by working out the values inside the brackets.

The next step is to calculate them to the power of your loan period, multiplied by the number of times interest is paid each year (in this case 5 years x 12 monthly payments). This will simplify your equation into something a bit more manageable, like so:

From there, a couple of quick calculations should give you an easy equation and a solution for your new savings account balance.

When we put this one through our savings calculator, it gave us an answer of $13,675. Considering we were rounding to the nearest decimal place, that’s spot on!

To work out how much interest you’ve earned, you’ll need to add your original balance and your deposits, and subtract them from the new balance. The formula for that might look like this:

In our example, the total interest earned was $1,174.92. That means that by making $100 deposits each month, you’ve earned a little over $360 more in interest than you would have otherwise.

Interest is usually a fee for borrowing money. That’s pretty straightforward in the case of a home loan - but when we’re talking about savings, what does borrowing money have to do with it? 

When you put money away in a savings account, that’s essentially you lending the bank your money. It’s still accessible to you at any time, but while you’re not using it, the bank can. 

In return for that, they pay you interest each month as a little thank you. How much interest you get depends on your balance and the interest rate the bank is offering.

Different elements play a role in determining the amount of interest accrued in your savings account. Some factors include:

Interest rate

Interest is calculated as a percentage of your savings, determined by the interest rate your bank is offering. When shopping around for a savings account, you’re looking for the highest interest rate available. But remember to also consider savings accounts with introductory or bonus rates.

Cash rate

The cash rate, set by the RBA, is the interest rate charged on overnight loans between financial institutions. This rate influences the economy by affecting currency exchange rates, inflation, and the overall cost of borrowing (say for a home loan), which is also usually passed on to savings and term deposit rates. Since savings accounts have a variable rate, this change can be felt pretty immediately - especially when there are hikes or cuts.

Interest payment schedule

Most savings accounts will generate interest on a daily basis, but pay it monthly, which is what you need to know to use our formula above. If you’re considering other savings strategies the calculations might be different. For example, a term deposit typically only pays interest once, at the end of the fixed term.

Savings balance

The amount of savings you can stash away in your account in the first place will affect how much interest you earn. Look at it this way: 2% of $100 is more than 2% of $10. If your money is split between a couple of places, you could instead pool it and stick it in a high interest savings account to earn as much interest as possible.

Deposits

The best way to plump up your savings? Keep funnelling money into it. Making regular deposits can not only boost your bank balance, but also the amount of interest you’ll earn in a month, because it’s being calculated on a larger figure. If you’re after bonus interest rates, many accounts have minimum monthly deposit requirements.

Time period

Generally, the longer your money remains in a savings account, the more interest you’ll earn. To work out how much that will be, you need to know how long you’re going to leave it there. If you’ve got a savings goal - say buying a home in five years - you’ll be able to work out if your current interest rate and deposit schedule will allow you to raise the necessary funds in time.

If you're ready to start earning interest on your rainy day fund, check out our extensive savings account comparison to find a competitive option that suits your financial needs.