Why Banks Pay You Interest At All

What banks do with your money

When you deposit money, you're lending it to the bank. The bank then lends that money to other customers as loans, charging a higher interest rate than they pay you. The difference is how banks make money.

The bank keeps the $50 difference. This spread between deposit rates and lending rates is the core of how retail banking works.

APY vs. APR

APY (Annual Percentage Yield) is what savings accounts advertise — it accounts for compounding and shows what you actually earn over a year. APR (Annual Percentage Rate) is what loans cost — it's a simpler rate without compounding. When earning: look at APY. When borrowing: look at APR.

Why rates change over time

Interest rates are influenced by the Federal Reserve, which sets a benchmark rate affecting what banks charge each other overnight. When the Fed raises rates, savings accounts pay more and loans get more expensive. When rates fall, the opposite happens.

This is why the rate on a savings account you opened a few years ago might differ greatly from new accounts today. It's worth checking periodically.

What this means for you

As a saver, you want the highest APY you can find on safe, accessible accounts. As a future borrower, you want the lowest APR you can qualify for. Understanding that rates move means you won't be caught off guard when they do.

Recap

• Banks pay you interest because you're lending them money — and they lend it out at a higher rate to profit.
• APY is what you earn on savings; APR is what you pay on debt.
• Interest rates change over time, driven largely by the Federal Reserve's benchmark rate.
• Next up: high-yield savings accounts — and why they can pay significantly more than a standard bank account.