We are independent & ad-supported. We may earn a commission for purchases made through our links.
Advertiser Disclosure
Our website is an independent, advertising-supported platform. We provide our content free of charge to our readers, and to keep it that way, we rely on revenue generated through advertisements and affiliate partnerships. This means that when you click on certain links on our site and make a purchase, we may earn a commission. Learn more.
How We Make Money
We sustain our operations through affiliate commissions and advertising. If you click on an affiliate link and make a purchase, we may receive a commission from the merchant at no additional cost to you. We also display advertisements on our website, which help generate revenue to support our work and keep our content free for readers. Our editorial team operates independently of our advertising and affiliate partnerships to ensure that our content remains unbiased and focused on providing you with the best information and recommendations based on thorough research and honest evaluations. To remain transparent, we’ve provided a list of our current affiliate partners here.
Finance

Our Promise to you

Founded in 2002, our company has been a trusted resource for readers seeking informative and engaging content. Our dedication to quality remains unwavering—and will never change. We follow a strict editorial policy, ensuring that our content is authored by highly qualified professionals and edited by subject matter experts. This guarantees that everything we publish is objective, accurate, and trustworthy.

Over the years, we've refined our approach to cover a wide range of topics, providing readers with reliable and practical advice to enhance their knowledge and skills. That's why millions of readers turn to us each year. Join us in celebrating the joy of learning, guided by standards you can trust.

How is Deposit Interest Calculated?

By A. Rohlandt
Updated: Feb 26, 2024
Views: 7,089
Share

Deposit interest, or the money paid as an incentive for saving or investing is calculated using a straightforward formula where the balance is multiplied by the percentage of the interest expressed as a decimal. For example, 10 percent interest on $1,000 US Dollars (USD) would be calculated as $1,000 USD x .10 or $100 USD. Where the calculation of deposit interest can get confusing is in what is known as compounding. Compounding is the process of taking the interest that has been earned during a certain time period and adding it to the balance, then calculating again for the next period starting with the increased balance.

How the balance is compounded is stated in the terms of the certificate of deposit (CD) or the rules of the savings account. Also requiring definition is how the balance will be reckoned; for daily compounding, this is generally understood to be the balance of the account at the end of the previous day. For other terms of compounding i.e., quarterly, monthly or other, this is important because it can affect the amount of interest earned on a deposit.

In the example used above, for daily compounding, the formula is changed to: balance x interest rate/365 + balance = new balance. Substituting, we find ($1,000 USD x .10/365) + $1,000 USD = $1,000.27 USD. The new balance of $1000.27 after one day is then placed at the beginning of the equation for the next day. Compounding daily would yield a balance of $1105.16 USD after one year. If this were computed as simple annual interest, the balance would be $1,100 USD.

For other compounding variants, the only difference would be by what number the interest rate would be divided; for monthly compounding it would be divided by 12, for quarterly compounding by four. So, for monthly compounding, the calculation would be thus: ($1,000 USD x .10/12) + $1,000 USD. At the end of 12 months, the balance would be $1,104.71 USD. Quarterly compounding would yield a balance of $1,103.81 USD. It can be seen that the more frequently compounding occurs, the higher the deposit interest earned.

Some institutions or account providers might stipulate conditions on how the balance is averaged to yield a lower amount on which the deposit interest is calculated. If a CD stipulated that the monthly compounding would occur on a balance that is equal to the average of the previous three months' balances, that would result in a lower amount multiplied by the interest rate and therefore, a lower return. A similar tactic is used by credit card companies to increase the balance on which interest charges are computed for their card holders.

Share
WiseGeek is dedicated to providing accurate and trustworthy information. We carefully select reputable sources and employ a rigorous fact-checking process to maintain the highest standards. To learn more about our commitment to accuracy, read our editorial process.

Editors' Picks

Discussion Comments
By anon172986 — On May 05, 2011

This is a very US centric description. Apparently, it's not as straightforward globally. Any idea where one can find information on the global Fixed Deposit interest accrual practices?

Share
https://www.wise-geek.com/how-is-deposit-interest-calculated.htm
Copy this link
WiseGeek, in your inbox

Our latest articles, guides, and more, delivered daily.

WiseGeek, in your inbox

Our latest articles, guides, and more, delivered daily.