Savings accounts are among the most basic banking services that many of us use. Understanding the basics of savings accounts can help you be a better consumer, choosing the best account for you, and helping you get the most for your money.
When you have a savings account, you are depositing money into a bank. The bank can then use this money to make loans to others. Having deposits is important to financial institutions. Indeed, savings accounts are deposit accounts that are designed for you to keep money in the bank. In order to encourage you to keep the money there, many financial institutions will pay you interest to keep your money there.
Banks make money by taking the money you have deposited in the bank, and lending it out at a higher rate of interest. Depending on the type of account you have, you might have different levels of access to your money. Accounts where you have the greatest access to your money will pay you a lower rate of return than other accounts. Some savings accounts have higher minimum balance requirements, and will place greater limits on how often you can withdraw money. You might receive a higher interest yield from such accounts, but you will face greater penalties if you do not adhere to the restrictions set forth. Most savings accounts at FDIC insured institutions are protected, meaning that your money is safe, up to $250,000.
Types of Savings Accounts
When choosing a savings account, it is important to consider your options. Here are some of the possibilities available to you with savings accounts:
Traditional Savings Accounts: These are accounts offered by most brick and mortar financial institutions. You usually do not have a minimum balance, and there are rarely fees. The returns on these accounts are usually quite low; you will not earn much of a yield.
High Yield Savings Account: You can find a number savings accounts now that offer higher yields. Many of these are online accounts, or accounts linked to special checking accounts or credit accounts the bank wants you to open. You might have a few more restrictions on these accounts, or be required to maintain a minimum balance.
Internet Savings Accounts (Online Savings Accounts): There are a number of banks that operate online only, or that offer special online bank accounts. You can usually find relatively high yields with these types of savings accounts, but you need to realize that your access to your money may be limited. It can take three or four business days for you to get your money with these accounts.
Money Market Accounts: There are also money market savings accounts. The interest rates on these accounts are more directly set by the money market. You might have to maintain a relatively high minimum balance in order to avoid monthly fees on this type of account, and there may be other restrictions.
Choosing a Savings Account
When deciding on a savings account, it is important to consider your individual needs. Many people decide to open different types of accounts to meet different goals. What works for you depends on a number of factors, including on whether you need quick access to the money, or whether you want to earn as high a return as possible. Decide what you want your money to accomplish, and then make a decision about your savings accounts based on your needs.
Conditions to Look For
While there are some banks that do not require minimum balances and deposits, there are those that require you to meet certain conditions if you want the higher yield. Some banks insist that you maintain a certain account balance if you want the attractive rate. If you don’t maintain the minimum, your interest rate will be dropped to something lower.
Other banks have a minimum deposit to open an account, but then have a higher balance requirement if you want to avoid fees. You might earn 1.10% on a balance of $1,500, but you might have to pay a fee of $7.95 per month unless you have an account balance of $2,500. Paying the monthly fee would erode your interest earnings. It is important to take the terms and conditions of the account into consideration before you deposit your money.
Some banks (many of them online) choose offer higher interest rates on savings accounts. To understand why this is possible, it is important to understand how a bank makes money off your deposit. It is quite simple: You deposit money in the bank using a traditional savings account. You might earn 0.25% as a yield. The bank takes that money and lends some of it (Federal Reserve rules make it clear that the bank has to keep some in reserve) out. On a mortgage, the bank might receive an interest rate of 5.2%. The bank makes money on the difference between the 0.25% it pays you and the 5.2% it charges a borrower.
If the bank is willing to close the gap between the two rates, earning less, it will offer a higher rate. On a high yield account, you might end up with a 1.10% yield. However, the bank will make less money, since the gap between what it pays you and what it makes on a loan is smaller. However, in order to attract borrowers, a bank might be willing to make that concession.
The Fed Funds Rate and Your High Interest Savings Account
In order to plan to get the best possible rate on your high interest savings account, it is important to pay attention to the conditions of the account, but also to pay attention to what the Federal Reserve is likely to do with the Funds Rate.Another thing you should be aware of is that your savings account interest rate will be affected by the Fed Funds Rate. This target rate is set periodically, either being raised or lowered. The yield on your high interest savings account will move up or down with the Fed funds rate. In times of economic difficulty, the Fed often lowers this rate in order to promote economic growth and encourage borrowing. Savings account yields fall as a result. When the economy is doing well, the Fed increases the Funds Rate in an attempt to limit inflation. When this happens, savers see better yields.
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