But most of us don’t know how the interest on these accounts is calculated.
Let’s look at how the interest is calculated to get a better understanding of the returns on the money saved in savings account.
Calculation of interest on Savings Account
According to the guidelines rolled out by the Reserve Bank of India in 2010, the interest on savings account is calculated on daily outstanding balance. It means that you earn interest on the bank balance you have at the end of each day.
The formula for the same is as follows,
Interest on savings account= Daily balance*Rate of interest* (No. of days/365)
Let’s try to understand it better with the help of an example.
Say, Mr. Anupam has Rs. 100,000 in his account on Day 1. He withdraws Rs. 50,000 after 7 days. And then deposits Rs. 30,000 on the 14th day. And thereafter there are no transactions. Assuming the rate of interest is 4%, let’s look at the interest he has earned for the month of January.
Here, the interest will be calculated as follows,
From 1.1.2018- 6.1.2018 the outstanding balance was Rs. 100,000. Thus, the interest will be calculated on Rs. 100.000 for 7 days, which is,
From 7.1.2018 to 14.1.2018 the outstanding balance was Rs. 50,000, upon which the interest shall be calculated for the period of 7 days,
From 14.1.2018- 31.1.2018 the outstanding balance was Rs. 80,000, on which the interest for 18 days shall amount to,
Thus, the total interest earned for the month of January will be,
Interest earned for the month of January
|Outstanding Balance||No. of days||Interest Calculation||Interest earned|
|Total interest earned||272.87|
Even though the interest is calculated on daily balance amount, it is credited to your account either half- yearly or quarterly based on your bank’s policy.
Calculation of Interest on Fixed Deposit & in case of Pre-mature Withdrawl
Fixed deposits generally pays higher interest than savings account. But it comes with a lock-in period. If you withdraw before the fixed tenure then a penalty is levied on the withdrawal, i.e. you will receive the amount after deduction of a small percentage of it, which generally ranges from 0.5%-1%.
The formula for calculation of interest is,
Interest= Principal*Rate of interest
Let’s understand this better with an example,
Ms. Ayushi has invested Rs. 100,000 in fixed deposit for a period of 1 year, earning an interest of 8% p.a. . The 6 month interest rate is 6%. Premature withdrawal penalty is 0.5%.
Case I: Ms. Ayushi withdraws after 1 year i.e. at maturity.
Case II: Ms. Ayushi withdraws after 6 months i.e. premature withdrawal
In the first case, where Ms. Ayushi completes the tenure of the F.D., she will earn,
Interest: 100,000*8%= 8000
Total Maturity value: 100,000+8000= Rs. 1,08,000
Thus, at the end of 1 year, Ms. Ayushi will receive Rs. 1,08,000
In the second case, Ms. Ayushi has withdrawn before the completing tenure of 1 year. She broke her F.D. after 6 months. In this case, the interest will be calculated differently.
Initially, when she had made the deposit, she had promised to keep the deposit for a period of 1 year for which the bank had offered 8% interest. But now that she is withdrawing earlier, the bank will pay her the revised interest which is applicable for a 6 month fixed deposit. In our case, it is 6%.
The point to note here is that because of premature withdrawal, the bank will not pay her interest at the rate of 8% for a period of 6 months. It will pay her interest applicable for a six month deposit period.
Along with it, the bank will also charge a penalty for breaking the promise, i.e. premature withdrawal, which is 0.5% in our example. Therefore, the effective interest that Ms. Ayushi will receive is, 6% – 0.5% = 5.5%.
Let’s see the calculation,
Interest (6 months): 100,000*5.5%= 5500
Pre-Maturity Value (6 months): Rs. 1,05,500
Hence, it is not just the interest rate that should be considered while calculating returns on Fixed Deposit. It is also important to plan and calculate the effect on your overall return in case you need to break the Fixed Deposit for premature withdrawal.
There are some banks who offer premature withdrawal without charging any penalty. But even in those cases, you need to check the effective interest you will receive on premature withdrawal (just like in our example, where due to premature withdrawal the interest rate was revised from 8% to 6%).