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How Does Interest Make Money Grow?

Earning interest on money in your savings account is one way to make money without having to do extra chores or wait for your next birthday present from grandma!

Everyone likes the idea of getting more money for less work, and earning interest on money you put in a savings account is one way to do that. So what is interest? It is the amount of money you earn by putting money into a savings account at your credit union. The amount of money you put into the account is called the principle, and the interest earned is a percentage of that principle. You could earn 1%, 3%, 5%, or more depending on the type of savings account.

Let’s See How It Works

If you open a savings account and deposit $100 (that’s the principle) and the account earns 10% interest once a year, you would have $110 total at the end of the year:stacks of coins growing plants

$100 x .10 = $10

$100 + $10 = $110

This is called simple interest because the 10% interest rate is only based on the initial principal deposit (that $100 you first put into the savings account). Using the same math as above, with simple interest, you would have $120 in the account after two years. Every year you would earn $10, assuming you always left at least $100 in the account.

But there’s another kind of interest that earns you even more money: compound interest. This kind of interest is calculated on the principle plus any interest it has earned in the past. In order to figure out the compound interest on your $100 deposit, we need to know one more piece of information: the compounding period. This is how often interest is calculated and added to your account. If it’s an annual compounding period, the interest is figured out and added to the account once a year. If it’s a semiannual compounding period, the interest is figured out and added to the account twice a year. Compounding periods can be as often as quarterly (four times a year) or monthly.

When you earn compound interest, the interest rate is split between the periods, so if you earn 10% with a semiannual compounding period (remember that means twice a year), you’ll earn 5% after the first six months and then 5% on the that new total in the last six months of the year.

Now we’ll do the math and see how compound interest earned more often makes you more money.

Annual Compounding Period

Principle: $100

Interest Rate: 10%

Year 2

$110 x .10 = $11

$110 + $11 = $121

Year 1

$100 x .10 = $10

$100 + $10 = $110

Year 3

$121 x .10 = $12.10

$121+ $12.10 = $133.10

Semiannual Compounding Period

Principle: $100

Interest Rate: 5%


Year 1 Period 1 (1st half of the year)

$100 x .05 = $5

$100 + $5 = $105

Year 2 Period 1

$110.25 x .05 = $5.51

$110.25 + $5.51 = $115.76

Year 1 Period 2 (2nd half of the year)

$105 x .05 = $5.25

$100 + $5.25 = $110.25

Year 2 Period 2

$115.76 x .05 = $5.79

$115.76 + $5.79 = $121.55

Year 3 Period 1

$121.55 x .05 = $6.08

$121.55 + $6.08 = $127.63

Year 3 Period 2

$127.63 x .05 = $6.38

$127.63 + $6.38 = $134.01

You earn more with compound interest than simple interest, and you earn more if the compound interest is calculated more frequently. The $134.01 total from a semiannual compounding period is more than the $133.10 of annually compounding interest—even if it’s just by a little bit!

Now you know about how to earn interest in a savings account. Are you ready to start growing your money with interest?


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