Compound interest accounts in the UK

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Compound interest is a term commonly used in the UK banking industry when talking about interest rates, savings and investments. But what does compound interest mean? On this page, you’ll learn what compound interest means for UK savers, how compound interest works, what compounding periods are and understand the benefits of opening compound interest accounts in the UK.

Key takeaways
  • Definition: Compound interest is the interest you receive on money that’s already earned interest

  • Savings growth: Accounts with compound interest typically mean you’ll be able grow your savings further

  • Calculation: You can calculate the rate of UK compound interest by using a simple formula

What is interest?

Interest is a way of generating money from money. You can earn interest from your savings or pay interest on the money you’ve borrowed.

Simple vs compound interest

Unlike compound interest, simple interest is calculated on the original deposit sum only. So if you deposit £10,000 into an account that pays 4% interest, you’ll earn £400 in interest every year. This means after, say, three years, you’ll have a total of £11,200 in the bank:

  • End of year 1 – £10,400 (4% of £10,000 is £400)
  • End of year 2 – £10,800 (£10,400 + £400)
  • End of year 3 – £11,200 (£10,800 + £400)

However, as we’ve already explained, compound interest takes a cumulative approach. Although it may seem a little more complicated, a compound savings account will allow you to earn more interest on your savings over time. This is the effect of compounding using the same figures in the above example:

  • End of year 1 – £10,400 (4% of £10,000 is £400)
  • End of year 2 – £10,816 (4% of £10,400 is £416)
  • End of year 3 – £11,248.64 (4% of £10,816 is £432.64)

Due to the ‘snowballing’ effect, you’ll earn an extra £48.64 if you opt for a compound interest savings account over a simple interest account.

While both types of interest will help your savings to grow, compound interest provides a welcome boost if you’re trying to make the most of your money.

What is compound interest in the UK?

In the UK, compound interest is the interest you earn from your original deposit combined with the interest you’ve earned so far. If you make deposits into a UK compound interest savings account where interest is paid annually, you’ll keep earning interest on each previous year’s interest. This means that if the rate of interest stays the same, you’ll earn more from your savings every year with your interest compounds.

Here’s a simplified example of how compound interest works in the UK:

If you deposit £2,000 into a savings account that offers a fixed interest rate of 10% and pays interest annually, you’ll earn £200 in interest on the first anniversary of opening your savings account, giving you a balance of £2,200.

If you don’t make any deposits or withdrawals during the second year, you’ll earn another 10% in interest, but this time, that 10% will be on a savings account balance of £2,200. 10% of £2,200 is £220, so that means you’ll earn £220 in interest, and your balance at the end of year two will be £2,420. You’ll have earned interest on your original deposit and also on the interest you earned in year one.

This is an overly simplified explanation of how compound interest works, as other factors affect how interest is calculated, paid and compounded, but this gives you an idea of the process. Compound interest means that the amount of interest paid on your savings will grow, even if you don’t make any more deposits. Of course, if you do make deposits, you’ll earn interest on those, too.

If the savings account you choose pays interest more than once a year, the compounding effect is greater as interest is paid more frequently. It’s always best to check how often interest is paid if you’re considering opening a compound interest savings account in the UK.

How do I calculate compound interest?

The formula for calculating compound interest for long-term comparisons looks complicated, but you really only need to remember how it works, as in the simplified example above.

The compound interest formula is A = P(1 + R/N)^NT, where:

A is the total Amount you’ll earn at the end of your term

P is the Principal, or the amount of your initial deposit

R is the annual interest Rate you’ll earn

N is the Number of times your interest will compound

T is the Time in number of years you expect to save for

What are ‘compounding periods’?

A compounding period is simply the time from one interest payment to the next. 

The rate of compound interest depends on how often interest is paid. If your interest period is quarterly or monthly, the total amount of interest you’ll earn at the end of one year will be higher because the interest you earn is accumulated over smaller periods of time. 

How to earn compound interest

From fixed rate bonds to easy access accounts and ISAs, there are various types of savings accounts that pay compound interest. However, not all savings accounts pay interest in the same way so it’s important to do your research. Some banks calculate interest on a yearly, quarterly or even monthly basis, while others require savings interest to be ‘paid away’ into another account entirely.

To find the best compound interest account, it’s a good idea to compare products from a range of providers. Make sure you pay close attention to how and when the bank pays interest. Whether interest is compounded annually or monthly can have a huge impact on the value of your savings in the long term. Generally speaking, the best compound interest accounts in the UK are those that offer a competitive rate of return and pay interest at frequent intervals.

How to make the most of compound interest

If you want to maximise the positive effects of compound interest, it’s important to choose a savings account that pays a competitive rate of interest at regular intervals. You’ll find a range of high-interest compound savings accounts in the Raisin UK marketplace.

To make the most of compound interest, it’s a good idea to open a savings account as soon as possible. Pay into the account as often as you can and, if possible, refrain from making frequent withdrawals so your money (and interest) has time to accumulate.

Compound interest can make a big difference to the value of your savings over time, but it’s important to be patient; the snowballing effect won’t happen overnight.

Benefits of opening a UK compound interest savings account

The main benefit of opening compound interest savings accounts is that you can earn more from your savings quicker than you would with savings accounts that don’t compound interest. The earlier you start saving, the more you will accumulate, which is especially beneficial if saving for retirement is one of your savings goals. The effect of compound interest vs. non-compounding interest, and how much more your savings could earn in interest, is illustrated in this simplified graph:

How to find the best compound interest accounts

If you want to find the best compound interest accounts, you’ll need to do your homework. You can start by visiting comparison websites to view a range of savings accounts in one place. However, bear in mind that not all savings accounts offer compound interest, so it’s important to check the terms of the account.

Once you’ve identified those that pay compound interest, you’ll then need to narrow down your selection. Some of the key factors to consider when choosing a compound interest account are:

  • Interest rate – the higher the rate, the more interest you’re likely to earn
  • Payment intervals – is interest paid monthly, quarterly or annually? The more regularly interest is paid, the greater the compounding effect
  • Bonus rates and incentives – is there a special introductory rate or another incentive for signing up?
  • Minimum deposit – some compound interest saving accounts require a minimum opening deposit – do you have a big enough lump sum to meet the criteria?
  • Maximum deposit – there may be a limit on how much you can save. If you wish to save more than this you may need to open another savings account
  • Notice period – how easily can you withdraw your cash? Do you have to give notice and, if so, how long?
  • Fees, charges and restrictions – will you have to pay any fees or charges? Is there a penalty for withdrawing your money?

When researching the best compound interest savings accounts, it’s important to compare like-for-like. Comparing the gross interest rate on one account with the AER (annual equivalent rate) on another, for instance, won’t give you an accurate snapshot. One reason for this is that the AER takes the effect of compounding into account, whereas the gross interest rate does not.

As a rule of thumb, the best compound interest accounts are those that offer a competitive rate of return and pay interest at frequent intervals. However, it’s also important to consider your savings goals as well as the variables outlined above, to find a compound interest account that suits your individual needs.

Compare compound savings accounts from a range of banks

If you want to quickly and easily open a compound savings account in the UK, register for a Raisin UK Account and log in to apply today. Opening an account with Raisin UK is free, and you’ll find competitive interest rates from a range of UK banks.