Interest is something most people are familiar with—whether it’s earned from a savings account or paid on a loan. But why do banks offer interest to customers in the first place? What’s in it for them, and how can you benefit?
Understanding how interest works, especially when it comes to deposits, is key to managing your money effectively. In this blog, we’ll explore why banks pay interest, how they use your deposits, and how you can make the most of interest-earning accounts. If you’re currently looking for a bank in Wilkes-Barre, PA, this information can also help you make informed decisions about where to keep your money.
What Is Interest?
Interest is essentially the cost of using someone else’s money. When you borrow from a bank—through a loan or credit card—you pay interest for the privilege of using their funds. On the flip side, when you deposit your money into a savings or interest-bearing account, the bank pays you a small percentage as a reward for keeping your funds with them.
This may sound like a nice bonus, but there’s more to it than just goodwill.
Why Do Banks Pay Interest?
Banks aren’t paying interest just to be generous. The interest you earn on your deposits is a direct result of how banks make money.
To Encourage Deposits
Banks need capital to operate, lend money, and fund investments. Your deposits help provide that capital. By offering interest on savings or certificates of deposit (CDs), banks give you an incentive to store your money with them instead of hiding it under a mattress or moving it to a competitor.
To Compete With Other Banks
Not all interest rates are the same. Offering higher rates can be a way for a bank in Wilkes-Barre, PA or elsewhere to attract new customers. Banks that offer slightly more interest may stand out in a crowded market, especially to savers who are comparing account options.
To Fund Their Lending Activities
When you deposit money, the bank doesn’t just let it sit there. It uses a portion of those funds to issue loans to other customers—like mortgages, business loans, or personal lines of credit. The bank charges those borrowers a higher interest rate than it pays you. That difference, called the net interest margin, is one of the main ways banks earn a profit.
For example, if a bank pays you 1% interest on your savings account but charges 6% interest on a personal loan, they make money from that spread.
How Do Interest Rates Work?
Interest rates vary depending on the type of account and the broader financial environment. Here’s how it usually breaks down:
- Savings Accounts: Typically offer lower interest rates, but allow easy access to your funds.
- Money Market Accounts: Usually offer slightly higher rates and may require a larger minimum balance.
- Certificates of Deposit (CDs): Provide the highest fixed interest rate but require you to leave your money untouched for a set period.
Banks also adjust interest rates based on federal monetary policy, inflation, and market competition. Rates may be higher when the Federal Reserve increases its benchmark rate and lower during economic downturns.
Compound Interest: How Your Money Grows Over Time
One of the biggest benefits of depositing your money into an interest-earning account is compound interest. This means you earn interest not just on your original deposit, but also on the interest that accumulates over time.
Here’s a quick example:
- You deposit $1,000 into a savings account with an annual interest rate of 2%.
- After the first year, you earn $20 in interest.
- In the second year, you earn interest on $1,020—not just your original $1,000.
- Over several years, that compounding effect grows significantly.
The more frequently the interest compounds (daily, monthly, quarterly), the faster your balance grows—even with a relatively low rate.
What Kinds of Accounts Earn Interest?
If you’re searching for a bank in Wilkes-Barre, PA, you may come across several account types that offer interest. Here are the most common:
Savings Accounts
Great for emergency funds and short-term goals, these accounts offer modest interest and high liquidity.
High-Yield Savings Accounts
Usually offered by online or regional banks, these accounts feature better interest rates but may have minimum balance requirements.
CDs (Certificates of Deposit)
A CD locks in your money for a fixed term—anywhere from a few months to several years. In exchange, you typically earn a higher interest rate than a standard savings account.
Money Market Accounts
These accounts often combine features of both savings and checking accounts, with higher interest rates and limited check-writing privileges.
Factors That Affect How Much Interest You Earn
While the account type is important, several other factors influence how much interest you’ll actually earn:
- Deposit Amount: The more money you deposit, the more interest you earn.
- Account Terms: Longer terms often come with higher interest rates, especially for CDs.
- Interest Compounding: Daily compounding grows your money faster than monthly compounding.
- Bank Policies: Each bank sets its own rate schedule and eligibility requirements.
Some banks even offer interest bonuses or loyalty perks for maintaining a certain balance or combining accounts, such as checking and savings.
How to Maximize Interest Earnings
You don’t need to be a financial expert to make your money work harder for you. Here are a few practical tips to help you earn more interest:
- Compare rates before opening a new account
- Opt for high-yield savings or CD options if you don’t need immediate access to the money
- Check compounding frequency
- Use automatic transfers to regularly add to your savings
- Avoid early withdrawal penalties on CDs
A local bank in Bilkes-Barre, PA may offer in-person guidance to help you choose the right account based on your goals.
Final Thoughts
Banks give you interest because it’s part of a larger system that benefits both parties. You earn a little extra just for storing your money in a secure place, while banks use those deposits to fund loans and make investments. It’s a cycle that keeps your money working—even when you’re not.
By choosing the right account, understanding how interest works, and keeping an eye on rates, you can grow your savings over time. Whether you’re just starting to save or looking to boost your current balance, partnering with a bank in Wilkes-Barre, PA that understands your financial goals can help you make smarter banking decisions for the long haul.