How Does a Savings Account Work?

Everyone has saved something at one time or another, from important papers, to pocket change. When children are first introduced to the concept of savings, it usually is with the gift of a piggy bank. This is simply the keeping of money in a safe place. When we get older, and go out into the world, we acquire a checking account, which also keeps our money in a safe place. These safe places are called current accounts in the UK.  Our money then sits in a bank, or credit union, and we write a check to pay for goods and services, subtracting the amount used from our checking account.

People often open a savings account when they first open their checking account. We know the basic idea of what a savings account does, it saves our extra money until we need to use it. It also pays us interest, not a whole lot, but it’s free to us for keeping our money in the bank. But there is a lot more involved than just putting your money into a saving account. Let’s look a bit closer to what happens to that money.

Savings accounts are very safe because our money is insured against loss if the bank closes or fails. Banks use the Federal Depository Insurance Corporation (FDIC), and credit unions use the National Credit Union Administration (NCUA), to protect our money. Both insurance companies work in the same way to protect our money. Some banks require a minimum balance in our savings accounts, while many others don’t have a minimum requirement.

The interest paid on a savings account is the money the account earns for letting the banking institution use that money to fund loans to other people. In other words, we are giving the bank permission to use our money, and they are paying us for that use. That money is called “interest.” Interest is often “compounded daily.” That means interest is calculated daily, including the interest already paid into the account. This means we are paid interest on the interest already there.

People often wonder how the bank can make money paying out interest in a cash isa account. Using our money to loan to other people is where the bank makes it’s money. The people borrowing money from the bank are charged interest, much more than what we are paid into our savings account. This interest from the loan payments keeps the banks in business. This is a simple explanation, but it will give you the basic idea of how a savings account works.

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