It’s currently difficult for Australians to earn any substantial interest in their savings account. Much like the fearsome ancient beasts that have now evolved into pathetic house pets, interest rates that used to be higher than 16% p.a. back in the 80s and 90s have now fallen to rates below 3% p.a. – and that’s being generous.

In today’s low cash rate environment, you’re hard pressed to find a savings account with a permanent ongoing interest rate that’s around 3% p.a., and even if they were they’d be subject to changes at the bank’s whim. But if you want to find the best possible interest rate for you, you need to know that there can be two components of a savings account interest rate:

  • The base rate
  • The bonus rate

What is a base interest rate?

The ‘base’ interest rate is the default interest rate on your savings account that you earn without having to meet specified conditions.

A scan of the current market (as at December 2018) shows the highest base interest rate on savings accounts is 2.20% p.a., while the average is around 1.50% p.a.

From the major five banks (the big four plus Macquarie), the average base rate is a mere 0.95% p.a. That’s less than the rate of inflation (1.90% as at September 2018), so in real terms, you would be making a loss on your savings at that rate.

What is a bonus interest rate?

The bonus interest rate is an extra interest rate some savings accounts offer on top of the base rate, either as an introductory rate for a limited number of months (also known as a honeymoon rate) or as a ‘conditional rate’ that account-holders could qualify for by meeting particular requirements each month. For example, with a conditional bonus rate, you might receive bonus interest for the month by meeting conditions such as:

  • Depositing at least $X into your savings account each month
  • Making zero or limited withdrawals each month
  • Having a linked transaction account with $X deposited each month
  • Making a certain number of transactions each month using the linked transaction account

Some accounts may require a combination of such conditions to be met to qualify for the bonus rate.

Savings accounts with bonus interest rates are much more likely to have a higher rate in total than one without, but there are some savings accounts that have a bonus rate with little to no base rate. There are at least a couple of dozen savings accounts with base rates of  0.15% p.a. or less, yet some of them have bonus interest rates as high as 2.50% p.a. A cynical person might think that these products are ‘banking’ on people not meeting the requirements listed in order to avoid paying interest.

Ensure you check what your bank’s bonus interest rate is (if it has one) and the conditions required to unlock your maximum interest rate.

The total interest rate

As you might’ve gathered, the total interest rate on your savings account is the base rate + the bonus rate – so a 1.50% p.a. base rate and a 1.00% p.a. bonus rate is a 2.50% p.a. total rate.

As at December 2018, the highest total interest rate is 3.10%, but this is a honeymoon rate. The highest non-honeymoon total interest rate is 2.90%.

Be wary of ‘honeymoon’ rates

Honeymoon rates – perhaps more commonly known as introductory rates (but that doesn’t sound as interesting) – are temporary interest rates offered in the first few months of opening an account. These interest rates are higher than the average, a deliberate tactic to try and entice new customers.

Of the five highest total interest rates on offer in December 2018, three of them include introductory bonus interest, allowing customers to earn nearly twice the base rate for as long as four months. Once these four months are over though, it’s back to the low base rate, which is not ideal for those looking to actually make a decent return on their savings.

It’s possible to ‘churn’ savings accounts like people do with credit cards (consistently changing accounts to take advantage of introductory offers), but this is much harder and more time-consuming to do with savings accounts. You also have to ask yourself: is it really worth changing banks every three to four months just to earn a few percentage points more in interest?

If the answer to this question is no, then you may just want to consider sticking to a high-interest account with no introductory rate.

How interest is calculated on savings accounts?

There are essentially three different components that work together to calculate your interest in a savings account:

  • The principal: the amount you have in savings, which increases with regular deposits
  • The interest rate: savings accounts use compounding interest, which means both the principal and additional interest earn interest
  • Time: how often interest is calculated and paid can have an impact on interest.

Most institutions will have a savings account calculator that will work out your final interest for you. But if you want to know exactly how it works, there’s a general formula for savings account interest:

A = P x (1 + R/n)n

  • A = your final amount
  • P = the principal
  • R = your interest rate as a decimal (e.g. 2.8% = 0.028)
  • N = number of time periods (e.g. interest calculated monthly for two years is 24 time periods).

Savings accounts calculate interest yearly, quarterly, monthly or even daily, which can lead to different interest returns. You should check the terms and conditions to see which it is with your bank.

Let’s say you have an initial deposit of $5,000, and don’t make any extra contributions. Your interest rate is 2.80%, and your bank calculates and pays interest on a monthly basis. After one year, your interest calculation would look like this:

= 5,000 x (1+ 0.028/12)12

= 5,000 x 1.002312

= $5,141.8

In this example, you’d have earned more than $141 in interest in one year, or nearly $12 a month. If you were to make regular contributions to your account, your principal would increase every time the calculation is made, and so would your final figure.

Let’s take a look at how much of a difference regular contributions can make to interest earnings over a five year period:

Balance 0.01% interest rate 1.00% interest rate 2.00% interest rate 3.00% interest rate
$5,000 $2.50 $256.25 $525.39 $808
$5,000 + $100 fortnightly contribution $5.78 $590 $1,204 $1,843
$5,000 + $100 weekly contribution $9.09 $926.33 $1,887.95 $2,886.30

The effects of compound interest on a savings account are exponential – the more you have in there and the more you deposit on a regular basis, the more interest you earn.

Does your interest rate even matter?

Savings account interest rates might be low now, but that doesn’t mean they’ll be that way forever. Unlike term deposits, savings accounts have variable rates – if your provider decides to increase interest rates (which they very well might do if the cash rate is raised), you would benefit from this increased rate, and aren’t locked into the rate you received when you first joined.

Secondly, rates between two and three percent are still better than nothing – you can see in the example above that you can still earn decent interest with rates as they are. The only problem is inflation.

As stated earlier, the rate of inflation – that’s the rate at which goods and services increase in price over a period of time – is 1.9%. As things stand, a $50 bill today will be worth 1.9% less in a year’s time, since the actual value of money is decreasing. An interest rate below the rate of inflation means that even if you’re earning interest, you’ve technically lost money.

So try to factor in your ‘real rate of return’ when selecting a savings account: that’s the total interest rate minus the rate of inflation. PLUS, the Australian Taxation Office’s (ATO) investment income page states that any interest earned from financial institutions must be declared as income in your tax return. So in addition to inflation, you’re also charged your marginal tax rate on your interest!

So your interest rate does matter – if it’s too low, you won’t earn anything.’s two cents

It pays – literally – to be aware of the fine print regarding your savings account. Before you get swept away by a seemingly high interest rate, ask yourself the following questions:

  • Is this interest rate introductory, or ongoing?
  • What is the base rate compared to the bonus rate? Does it even have a bonus rate?
  • Can you meet the bonus rate conditions?
  • How often does it calculate interest?

You should also frequently monitor your account’s interest rate to make sure it hasn’t changed. Normally your bank will notify you of such changes, but not always.