However, paying or earning interest on our money doesn’t mean we understand it. That’s a problem — especially when we’re talking about savings; interest rates are one of the most fundamental things you should know about finance.
What is Interest?
Interest rates are basically costs to rent access to money — and, yep, that includes money in savings accounts and funds loaned out to members by a financial institution.
“Banks borrow money from individuals through checking and savings accounts and lend that same money back out to businesses and consumers,” said Scott Sullivan, a commercial real estate lender at Stonebridge Bank in Minneapolis, Minn. “In order to borrow money from individuals, banks must pay them interest.”
There are a few factors that play into interest rates, including the supply of money and the type of account.
• Who? Based on broader monetary and economic goals, the Federal Reserve Bank sets the federal funds rate, which triggers changes in interest rates paid by financial institutions.• How? When looking at the bigger picture, changing interest rates impact the amount of money moving around in the economy. If interest rates are high, for example, there’s incentive to keep our money in financial institutions and cash in on that interest, and our borrowing decreases because we have to pay more to borrow. These factors decrease the amount of money circulating in the economy, which reduces spending and slows economic growth.
• Where? To find a savings account with a decent interest rate, research the annual percentage yield (APY) offered on an account; those percentages are used to calculate the interest your money will earn. The APY is the annual rate of return on your investment (read: the money you’re stashing in your savings account) and is based on a 365-day year.
In 2015, the APY for most savings accounts sat between 0.85 to 0.90 percent. While those look like small percentages, we still get some “free money” out of those interest rates, and that’s happy news any day. Deposit $1,000 into a savings account with a 0.90 percent APY, for example, and you’ll get a whole $9 after 365 days without breaking a sweat. Larger deposits, longer savings periods and higher interest rates only yield more. If you know what to look for in interest rates, you can grow your money without lifting a finger.
That’s easy money and easy savings.