The popularity of online banks has surged since the internet became commercialized in the late 1990s and early 2000s. University researchers have found that online banks have increased their deposits by a factor of 30 since 2001, growing at three times the rate of traditional banks during the same period.
Why is this happening? Customers are attracted to the higher interest rates and lower fees that online banks typically offer on deposit accounts.
It’s clear that banking customers favor higher rates and lower fees. But what enables online banks to consistently provide the most competitive savings options? Let’s delve into the details.
How do online banks afford to pay higher deposit rates?
While each bank operates differently, the ability of online banks to offer higher deposit rates generally stems from a combination of lower costs and heightened competition.
Reduced overhead
Online banks generally incur lower overhead costs compared to traditional banks, primarily because they do not operate physical branches. This eliminates expenses associated with leasing buildings, utilities, maintenance, and other operational costs tied to maintaining physical locations. Essentially, the absence of a vast network of branches significantly reduces their overall expenditures.
However, online banks do not retain all the savings from these reduced overhead costs. They frequently pass on these savings to consumers, which often results in higher deposit rates and lower fees.
Attracting Deposits
A key revenue stream for banks is lending out customer deposits to individuals and businesses. Therefore, it is crucial for banks to incentivize customers to keep their money in their accounts. Online banks, which are often newer and lack the brand loyalty of established traditional banks, might offer higher interest rates to attract and retain customers.
Competition
The banking industry is highly competitive, a scenario intensified by the advent of online banks. Customers are no longer limited to local banks; they can now open an account with any online bank from anywhere in just a few minutes.
With numerous online banks competing for the same pool of customers, there is a relentless pursuit to offer the best rates. Theoretically, the bank that offers the highest interest rates can attract more customers away from its rivals.
Examining the top online bank interest rates
According to the FDIC, the national average savings account rate is merely 0.46%. However, many online banks offer interest rates exceeding 5% APY.
Nonetheless, the interest rates for online savings accounts seldom surpass the federal funds rate, which is the rate banks charge each other for overnight loans. As of August 22, the Federal Reserve’s target range is between 5.25% and 5.50%.
Even online banks aiming to offer high deposit rates seldom surpass the upper limit of the current range. Those that do often come with stipulations. For example, Poppy Bank offers an APY of 5.50%, but requires a minimum balance of $1,000. MyBankingDirect provides a 5.35% APY with a minimum deposit of $500 to open an account. Similarly, Flagstar offers a 5.35% APY, but mandates a minimum balance of $25,000, and this high rate is only guaranteed for five months.
Top Online Bank Savings Rates
As previously mentioned, online banks offer attractive rates to draw in deposits and maintain a competitive edge. However, the competitive landscape means that these rates can frequently change. Currently, these are the best available online savings rates:
Best Online Bank CD Rates
If you want to avoid the unpredictability of variable savings account rates, which can fluctuate frequently, you might consider a certificate of deposit (CD). These accounts typically offer fixed interest rates, allowing you to lock in your annual percentage yield (APY) for the entire term.
The downside: You generally cannot make withdrawals from a CD before its maturity date without incurring penalties. However, some consumers might find this a reasonable tradeoff to avoid the risk of declining savings account rates, particularly as interest rate cuts appear increasingly likely this year.
If such cuts occur, deposit rates will likely decrease as well. By securing one of today’s top CD interest rates, you can protect yourself from the potential drop in deposit rates.
Is an online bank the right choice for you?
Online banks provide numerous advantages, such as high interest rates, minimal fees, and low minimum balance requirements. These benefits appeal to consumers looking to maximize their savings, particularly those who predominantly use mobile devices for their banking needs.
Nevertheless, online banks do have certain drawbacks. The absence of physical branches means you cannot have face-to-face interactions for assistance, although many online banks do offer 24/7 customer support through phone, email, or live chat. Alternatively, local community banks or credit unions may offer competitive savings account rates and provide more personalized service.
Additionally, many online banks feature convenient mobile check deposit options. However, depositing cash can be more challenging and may incur fees.
Similarly, although some online banks provide access to extensive ATM networks, this feature is not universal. Banks that lack this benefit may offer reimbursement for third-party ATM fees, up to a certain limit, but you are still required to pay the fee initially.
In summary, online banks come with a mix of advantages and disadvantages. If you determine that the benefits outweigh the drawbacks, they can serve as an excellent place to manage your finances. Nonetheless, you have the option to maintain your traditional bank account while also utilizing an online savings account. This dual approach allows you to enjoy the in-person services of a traditional bank, in addition to the perks offered by online savings accounts.