Savings & investments guide to interest rates

Interest rates are constantly shifting, driven by inflation and borrowing demand. In recent years, the Bank of England (BoE) raised the base rate to curb inflation and stabilise the economy. While this posed challenges for borrowers, it created opportunities for savers to enjoy higher returns on their cash. But with the BoE’s recent base rate cut – the first since March 2020 – some interest rates are now starting to edge downward, signalling the beginning of a new phase for savers and investors.

Even small changes in interest rates can impact your savings, so staying informed is key. By choosing a competitive high-interest savings account, you can make sure your money is working harder for you.

In this guide, you’ll learn how interest rates work and the advantages of high-interest savings accounts, helping you to choose the best option for your financial goals.

What are interest rates?

Interest rates refer to either the amount a lender charges a borrower for their line of credit, or the amount you can earn on your savings or investments. So, in simple terms, the interest rate will tell you how high the cost of borrowing is, or how highly you’ll be rewarded for your savings. In this guide, we’ll be exclusively looking at interest rates for savers and investors – so, the rate you’ll be rewarded for depositing money into a savings account.

Rising interest rates are favourable for savers, as they can lead to higher returns on savings accounts. But for investors, higher interest rates can present challenges. This is because increased borrowing costs often lead to reduced consumer and business spending, which can negatively impact stock market performance. As a result, investment growth may slow down during periods of rising rates.

How do interest rates work for savings and investments? 

Interest rates affect savings and investments in different ways. Understanding these differences is key to maximising your returns. Here's a comparison of how interest rates influence savings accounts versus investments.

Savings

Interest on a savings account is the money a bank or financial institution pays you for depositing your funds with them. The bank borrows your deposited funds to lend to other customers. They pay you interest on your savings while charging borrowers a higher rate. This is why a fixed-term savings account will tend to offer you a higher interest rate. For a set period, the bank has guaranteed access to your account, and you have a limit on the number of withdrawals you can make.

You’ll earn interest every day, but the interest will usually be paid into your account monthly, with some accounts paying quarterly or even annually. If you’re unsure how often your interest is paid, check with your bank or provider.

Investments

For investors, rising interest rates often signal a challenging environment for stock markets. Higher rates can indicate slowing economic growth or potential economic contraction. This typically puts pressure on corporate earnings and market performance.

But there’s a silver lining. Rate hikes are often anticipated, and global markets often factor them in ahead of time. Therefore, any immediate impact on your investments might be less pronounced than anticipated.

In the face of interest rate changes, maintaining a diversified portfolio and staying informed about economic indicators can help you navigate market fluctuations effectively.

Learn more: Building a diversified portfolio

Types of interest rates for savings and investment

When choosing the right savings account, the interest rate on your deposits is often a key factor. As there are different types of savings accounts, there are also different types of interest rates. These can affect your savings goals and the return you’ll receive on your account balance.

Understanding the different types of interest rate can help you to effectively compare savings accounts and choose one that aligns with your personal financial goals and needs. Let’s explore these rates in more detail.

What is compound interest?

Compound interest refers to the interest you earn from your original savings deposit, combined with the interest you’ve earned so far. So, you’re essentially earning interest on the interest itself. 

For every year your money sits in your savings account, you can earn interest on the previous year’s interest. So, as your savings grow over time, the rate at which they grow increases too.

The rate that the compound interest increases depends on how regularly interest is paid into your account. If the interest period is quarterly or monthly instead of annually, the total amount of interest paid across the year will be higher. With this in mind, it can be a good idea to check how often interest will be paid if you’re looking to open a compound-interest savings account.

A key benefit of compound interest is that your savings will continue to grow, even if you don’t contribute any more deposits to your account. But if you do choose to make further deposits, you’ll earn interest on those too. 

Learn: The benefits of compound interest

What is Annual Equivalent Rate?

Annual Equivalent Rate (AER) is the official interest rate for savings accounts. It enables you to draw comparisons between savings accounts and calculate how much interest you would earn over a year, regardless of the term or type of account. The calculation also factors in any account bonuses, compound interest, and bank charges that may apply.

AER should show you what interest you’d earn over a year if you put money into the account and didn’t touch it for 12 months. If your savings account pays interest annually, you’ll need to multiply your initial deposit by the AER. If you’re looking to compare accounts to make the most of your savings, AER is a good place to start. It can give you a full picture of how much interest you would earn for each savings account, enabling you to choose an account that suits you and your financial situation best.

What is gross rate?

Calculated as a percentage, gross rate refers to the annual rate of interest you’ll be paid on your savings or investment. The gross interest figure is the total interest you’ll see before any tax deductions, fees or bank charges. This is why gross interest is always higher than net interest – net interest is the amount you’ll receive after these deductions.

While they may sound similar, gross interest rate and AER aren’t one and the same. Instead, gross interest is the rate you’ll earn when you first open your savings account, while AER is how much interest you’ll earn over a year. AER can help you to compare savings accounts as it factors in compound interest, while gross rate is just a flat rate of interest before these factors have been considered. 

What factors influence interest rates for savings and investments?

Interest rates go up and down to reflect economic change, as well as buying and borrowing behaviours at the time. Here are some key factors that can influence interest rates for savings accounts:

• Type of account: The type of savings account you choose can affect the interest you’ll earn on your deposits. If you choose a fixed-rate savings account, for instance, the interest rate will be fixed for an agreed period of time, as long as you don’t withdraw money before the end of the term.
  
  
• Bank of England base rate: Interest rates are influenced by the BoE’s base rate. So, if the base rate goes up or down it can affect the interest rates that banks offer to their customers.
  
  
• Inflation: Economic factors like inflation play a major role in interest rates. The lower the interest rate, the more inclined consumers are to borrow money and spend. This increased spending can cause prices to go up, and if demand starts to outpace supply, interest rates can rise to slow down increased borrowing and spending.
  
  
• Competition: If one bank changes their interest rates, it’s common for other banks to do the same. This can help them manage the growth of their business as sustainably as possible.

How does the Bank of England interest rate affect savings rates?

The BoE sets the Bank Rate, or base rate, for the UK. This can then influence what interest rates banks across the country offer. For savers, if the base rate rises you would expect to see the interest you earn from your savings increase. The BoE usually raises interest rates in an effort to tackle inflation. If people face higher borrowing costs, such as higher interest rates on loans and credit cards, they’re less likely to spend. But the Bank Rate isn’t the only factor that affects interest rates – they can change due to other factors explained above. 

How do world events affect high-interest savings accounts?

World events, such as a global pandemic or conflict, often create a demand for borrowing. Events such as war, for example, often cause inflation, financial disruption, and interest rates to rise. If the inflation rate increases, the central bank of a country may try to tackle it by raising its interest rates. But high-interest rates do not always make your savings increase in value.

Inflation can cause savings to lose value, meaning your money ends up being worth less than before. When inflation runs high, your savings are at risk of losing value in real terms. For example, if inflation averaged at 3% over the next five years, what cost you £1,000 today could cost you £1,159.27 in five years' time. 

How do interest rates work with a savings account?

How interest rates operate with savings accounts often depends on the type of savings account you choose. Learn how interest rates work for different types of savings accounts:

Fixed-rate

With a fixed-term savings account, you typically earn a higher, guaranteed interest rate compared to other accounts. This rate remains the same throughout the term, so you know exactly what return you'll receive.

In exchange for this fixed rate, your funds are locked in until the end of the term, which can range from one to several years. Early withdrawals may result in penalties or reduced interest, so it's important to invest only money you can afford to leave untouched.

Interest is generally paid at regular intervals or at the end of the term. Be sure to check for any minimum or maximum deposit limits and whether the account automatically renews at the end of the term.

Overall, fixed-term accounts can provide attractive returns if you can commit your money for the whole period.

Notice

Notice accounts are a smart choice if you don’t need immediate access to your funds and can plan ahead for withdrawals. To access your funds, you’ll need to give advance notice to your savings provider, followed by a brief withdrawal period. Typical notice periods can range from 30 to 90 days, depending on the account.

In return for this advance notice, you usually receive a higher interest rate compared to instant access accounts, allowing your money to grow more effectively. But be aware that withdrawing funds before the end of the notice period may result in penalties or reduced interest rates.

It's also important to check if the interest rate is fixed or variable, and be sure to review any minimum deposit requirements or account fees. Some notice accounts may have limits on the number of withdrawals you can make, so understanding the full terms and conditions is essential.

Instant access

Instant access accounts offer the advantage of flexibility, allowing you to deposit and withdraw funds whenever you need them. This makes them a convenient choice for managing emergency funds or short-term savings goals where instant access is important.

Interest rates on these accounts are typically variable, adjusting in response to changes in the BoE’s base rate. While rates can fluctuate, these accounts provide a practical solution for savers who value liquidity and immediate access to their money.

Some instant access accounts may have limits on the number of withdrawals you can make each year, so it’s helpful to check the account terms. Overall, the ability to access your funds at any time can be a significant benefit in managing your savings.

How is tax calculated on savings interest?

So, you’ve earned significant interest on your savings deposits. Next, you’ll need to understand how much you’ll be taxed on the interest you’ve earned.

There are limits for the amount of interest you can earn tax-free, which depends on your salary and earnings. This is known as the Personal Savings Allowance (PSA) – a tax-free allowance that lets you earn interest on your savings without needing to pay tax. This allowance amount varies depending on the rate of income tax you pay.

For example:

• Basic rate taxpayers can earn £1,000 worth of interest tax-free.
• Higher rate taxpayers can get £500 worth of interest tax-free.
• Additional rate taxpayers don’t qualify for a tax-free allowance.

You’ll pay tax on your savings interest at your standard Income Tax rate. If you're employed or receive a pension, HMRC will adjust your tax code to ensure the tax is deducted automatically. This code is based on HMRC’s estimate of your interest income for the current year, using your earnings from the previous year.

Are high-interest savings accounts protected?

When depositing large sums, it's important to ensure your money is protected if your bank fails. Savings accounts regulated by the Financial Conduct Authority (FCA), including high-interest, standard, and fixed-term accounts, are covered by the Financial Services Compensation Scheme (FSCS) up to £85,000 per person, per financial institution. For joint accounts, this protection doubles to £170,000.

The protection applies to each financial institution separately, so if you have accounts with multiple providers, each one is covered up to the limits stated. To verify if your provider is covered by the FSCS, you can check their website or contact them directly.

A cash-deposit platform can be a great way for you to spread your deposits across multiple accounts to maximise your protection.

Learn more: Protecting your savings with the FSCS

How do you find the best interest rates?

Looking for a way to move, place, and spread your deposits to maximise the return on your savings? Comparing different options and keeping up with current rates is important, though it can take some time.

You can access the best interest rates across our market-leading banking panel, quickly and easily with just one single application. Our cash deposit platform offers access to hundreds of accounts from up to 50+ banks, with exclusive interest rates to help you grow your funds.

See how much interest you could be earning on your cash