Your bank may be paying tiered interest on a whole balance or partial balance method. The whole balance method is more common.
Whole balance method
This is the more common method of tiered interest rates. You are provided with a list of tiers and whichever tier the rate falls into, is the tier that applies.
Example
Lower limit | Upper limit | Rate |
0 | 1,000,000 | 1% |
1,000,001 | 5,000,000 | 1.5% |
5,000,001 | - | 2% |
Assuming your balance is 2,000,000 the interest rate will be 1.5% on the whole balance.
Partial balance method
This is the less common method of tiered interest rates. You are provided with a list of tiers and an effective rate is calculated from this, by calculating a weighted average. This is best explained with an example.
Example
Lower limit | Upper limit | Rate |
0 | 1,000,000 | 1% |
1,000,001 | 5,000,000 | 1.5% |
5,000,001 | - | 2% |
Example 1
Assuming your balance is 2,000,000 the interest rate will be calculated as follows:
Step 1 - weight the rates with the balance falling into the tier
Tier 1: 1,000,000 x 1% = 1,000,000
Tier 2: 1,000,000 x 1.5% = 1,500,000
Step 2 - calculate a weighted average
Effective rate: (1,000,000 + 1,500,000) / 2,000,000 = 1.25%
Therefore the effective rate applied to the balance is 1.25%.
Example 2
Assuming your balance is 7,000,000 the interest rate will be calculated as follows:
Step 1 - weight the rates with the balance falling into the tier
Tier 1: 1,000,000 x 1% = 1,000,000
Tier 2: 4,000,000 x 1.5% = 6,000,000
Tier 3: 2,000,000 x 2% = 4,000,000
Step 2 - calculate a weighted average
Effective rate: (1,000,000 + 6,000,000 + 4,000,000) / 7,000,000 = 1.57%
Therefore the effective rate applied to the balance is 1.57%.
š” If you have a flat interest rate, it doesn't matter whether you select whole or partial balance method. The effect will be the same.