Banking Basics: Knowing the Differences
These tips will help you differentiate between types of banks, types of bank accounts, and what will help you get the highest rates.
Deposit Accounts are Insured
Money placed in a bank that is insured by the Federal Deposit Insurance Corporation (FDIC) is covered up to $250,000 per account, per depositor. You can find out if a bank is insured by using the FDIC's bank finder here: FDIC Bank Find.
Money placed in a credit union that is insured by the National Credit Union Administration (NCUA) is also insured up to $250,000 per account, per depositor. The NCUA has a credit union locator tool here: NCUA CU Locator.
Money in a savings account, certificate of deposit account, or money market account that is insured is one of the safest places to keep your money. The downside to this is that deposit accounts currently offer some of the lowest returns but at least your principal isn't at risk, unlike many other investments.
By Federal law you are also limited to six withdrawals per billing cycle in a savings account. Regulation D, 12 Code of Federal Regulations(CFR) 204.2(d)(2), states that the depositor is permitted to make up to six pre-authorized transfers or withdrawals per month or statement cycle of at least four weeks. There is no regulation limiting the number of deposits into the account.
When you use a savings account as a savings account but you make more than the six pre-authorized transfers or withdrawals per month, your savings account will be converted to a transactional account.
Another type of bank account is a transactional account that allows ATM withdrawals and check writing privileges. These types of accounts (usually checking accounts) offer even lower interest rates than deposit accounts and often have monthly fees associated with the account. Sometimes these fees are also passed on a "per transaction" basis and can add up to hundreds of dollars a year.
Just like with a deposit account, the interest rate on a transaction account can vary greatly. The monthly fees can also vary greatly between different financial institutions so it's best to check around for the highest rates along with the lowest fees. ATM fees are also costly and usually your bank won't charge a fee if you use one of their own ATMs but you may be charged a fee anywhere between two dollars and four dollars if you use another bank's ATM. Adding insult to injury, the other bank may also charge you a fee from one to four dollars for the luxury of using their ATM.
Rates vs. Annual Percentage Yield
When you're comparing accounts and interest rates, you'll see two different interest rates listed - the rate and the annual percentage yield (APY). The rate is the actual interest rate on the account and the APY is interest that is compounded on the account annually. APY works this way, at first the money you place in the account (principal) earns interest, over time the principal earns more interest and the interest earned also earns interest.
Interest earned that earns interest is known as compound interest, over time compound interest is one of the most effective ways to earn money. The sooner and more often a bank or credit union pays interest, the higher the APY will be on an account. Interest earned can be paid, daily, monthly, quarterly, or even annually.
Inflation is the Biggest Threat
Savings account rates, money market rates, and CD rates are all determined by the current rate of inflation. When inflation is high these rates are high, and when inflation is low, these rates are low. Right now interest rates are at historic lows so when you shop around, don't be shocked when you see the best savings rates at 1.00 percent and the best CD rates on 1 year CD accounts also at 1.oo percent.
The annual increase in the costs of goods and services is known as the inflation rate. Whether the rate is low or high, with a deposit account your money is usually barely keeping up with the rate of inflation. Over the past 12 months, the inflation rate was 1.1 percent - just above where current savings rates and where 1 year bank CD rates are.
Finding the Best Interest Rates
Finding the best rates on an account will take some work on your part though because of the internet the process is considerably easier than it used to be.
You can easily compare rates on all types of deposit accounts by using our rate tables here: CD rates, savings rates, checking rates.
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