Savings & investments guide to interest rates


Interest rates rise and fall depending on the state of inflation and the increased demand for borrowing money. In recent months, interest rates have risen to slow down price increases and help to keep the economy stable. While rising interest rates can be bad news for borrowers, making lines of credit more expensive to maintain, a rise in interest rates can benefit investors looking for a higher return on their savings balance.

Even a slight change in interest rates can have an impact on your savings, so it’s best to keep an eye on whether they rise, fall or remain the same. A savings account with high interest can maximise the return on your money.

Here, we’ll dive into how different interest rates work and the benefits of savings accounts in the UK, to help you find the best high interest savings accounts.


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 at for depositing money into a savings account.

When you see interest rates rise, this is usually good news, as you’re likely to see higher returns on your savings. But high interest rates can be seen in a less positive light by investors, as stocks tend to decline in value. This is because consumers and businesses often spend less on goods and services when the cost of borrowing is higher. This therefore causes your earnings to grow at a slower rate.


How do interest rates work for savings and investments? 

Interest rates affect savings and investments in different ways. It’s important to know how interest works with both options, so you can receive the best return possible. Here, we’ll compare how interest rates work for both savings accounts and investments:


With a savings account, interest is the amount of money a bank or financial institution pays you for keeping your money with them. The bank is essentially borrowing money from you by using your deposited funds to lend to other customers. The bank then pays you interest for your savings account balance, while charging their borrowing customers a higher interest rate than the rate they pay you. This is why a fixed-term savings account will usually offer you a higher interest rate - because 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 for a period of time. 

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, be sure to check with your bank or provider.


When it comes to investments, as mentioned, higher interest rates are usually seen as a negative for stock markets. This is because they tend to suggest a period of slowing economic activity, or economic contraction, is on its way. 

On the plus side however, if interest rates do rise it's usually expected, so they may have already been priced in by global stock markets - in which case, you shouldn’t expect to see too much change.


Types of interest rate for savings and investment

When it comes to choosing the right savings account, how much interest you’ll earn on your deposits is often a deciding factor. As there are different types of savings accounts, there are also different types of interest rates that 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 reflects your personal financial goals and needs. 

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. 

What is AER?

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 Bank of England’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. 

Read more: Understanding inflation, the base rate, and GDP


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

The Bank of England (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. 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, unfortunately, 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. Here, we’ll explore how interest rates work for different types of savings accounts:

Fixed rate

With a fixed rate savings account, you’ll usually get a higher interest rate than other accounts, and one that’s guaranteed. This means the interest rate you’re offered won’t change during the term, so you know exactly what return you’re getting on your savings. In exchange for this higher fixed rate you won’t be able to withdraw this money until the end of the term (for example, two years). With this in mind, you should only lock away money you definitely won’t need access to. 


Notice accounts are a good savings option if you know you won’t need access to your money immediately. As the name implies, you’ll need to notify your savings provider in advance each time you wish to withdraw money. From there, there’s a withdrawal period before the money can be released to you. In return for this, you’ll get a higher interest rate than you would with an easy or instant access account. Make sure to read the terms and conditions of the account carefully, as some notice accounts restrict the number of withdrawals you can make. 

Instant access

As the name suggests, an instant access account is a savings account with no limits on withdrawals. Instead, you can transfer money and make withdrawals whenever you like. Just be mindful that some types of instant access accounts may enforce a limit on the number of withdrawals you can make in a year. With instant access accounts, interest rates are likely to be variable so they could change in line with the BoE’s base rate for example, and usually with short notice. So, while instant access accounts offer return on your deposits and flexibility in when you can withdraw, you’re likely to find higher interest rates elsewhere. 


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 usual rate of Income Tax – if you’re employed or receive a pension, HMRC will change your tax code so you pay the tax automatically. This tax code will be decided by HMRC estimating how much interest you’ll get in the current year, by looking at how much you earned in the previous year. 


Are high-interest savings accounts protected?

When depositing large amounts of money into a savings account, you’ll naturally want the reassurance that it’s protected should your bank fail. Thankfully, high interest savings accounts that are regulated by the Financial Conduct Authority (FCA) are protected under the Financial Services Compensation Scheme (FSCS) up to £85,000 per person, per financial institution. This limit extends up to £170,000 if your savings are held in a joint account.

A cash-deposit platform can be a great way for you to spread your deposits across multiple accounts to maximise your protection. Find out more about protecting your savings with the FSCS here.


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? Shopping around and market research is the only way to keep on top of new rates, but it can be time consuming.

You can access Flagstone's 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 Flagstone can help you – find out how much interest you could be earning today.


This article is not advice. If you would like advice on your savings and investments, consider speaking to a Financial Adviser.



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