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How do banks calculate interest on savings accounts? The account balance varies all the time, so what amount is the interest calculated on?

In: Economics

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I’m not going to say it’s like this on every bank out there, but a common way to do it is calculate interest on daily balances, but pay it out monthly.

We have computers. So it is quite easy to calculate what interest per second matches your agreed upon interest per year, and apply your interest calculation constantly to balances current each second.

I would assume it varies wildly from one bank to another as to precisely how they break down when to calculate your interest, and they do either an average balance (if they think people will read the contract) or a minimum balance (if they think nobody will) during each calculation period.

The interest amount stays constant. So as long as the interest is known, the bank can calculate how much interest is owed, even if the balance varies. Usually it’s calculated at the end of each month, so it could be based on the final balance of the month, or on the average balance for that account in a month.

EG- interest rate of .10 (10%), paid monthly. In June, balance is $1000, so it’s .10*1000, and interest owed is then $100. Or in August, average balance for the entire month was $500, no matter how many transactions took place. So it’s .10*500, which is $50.

These are both just easy numbers to work with. Sometimes interest is compounded, sometimes it’s not. That makes it even more detailed.