As we know a bank is an institution that handles money. When you deposit money it is stored in an account. Now it doesn’t just sit there. The bank will pay you to use your money to lend to others. Aside from charging you fees to use their services, that’s how banks make money.
Let’s look at this a little closer. Your account earns interest, or a percentage that a bank pays on your money. That interest is called APY, annual percentage yield. Now on your stored money that accumulated interest is being “compounded”, meaning its added back to the “principle”, the original amount of debt or investments.
So… say you have $5000 in your account and you’re APY is 2%. Most accounts compound quarterly so 2% divided into 4 quarters is .005%. The equation is 5000(1+.005) (1+.005) (1+.005) (1+.005). After one full year you’ll have $5100.75
Conversely when you borrow money, or take out a loan, the bank will charge you interest. That interest is called APR or annual percentage rate. When you make a minimum payment you are covering all of the interest and little of the principle.
The old saying is true, “It takes money to make money.” Banks are a good place to start saving money since the Federal Depositor’s Insurance Corporation (FDIC) insures your money from loss up to $100,000. However not all investments are FDIC insured and it’s unlikely that a bank will go under.
Checking: We all know that checking accounts are for short term deposits that you debit from. And that’s why checking accounts earn little to no interest.
Savings: These accounts offer low rates but still let you withdrawal your money.
Money Market: Now these accounts are more restrictive on the number of transactions and they are a little riskier. Meaning that they are not FDIC insured. These funds are usually invested in some type of debt.