If you’re about to open your first bank account, this article will help you understand how banks and bank accounts work.
We explain the different types of bank accounts and show you how to use bank accounts to your advantage.
You’ll also learn what interest is and why it matters, whether your money is really safe in a bank, and what “FDIC-insured” means.
Here’s what you’ll learn:
- What is interest?
- Is my money safe in a bank?
- Should I keep cash under my mattress?
- Types of bank accounts: savings, checking, money market, and CD
- What’s the difference between a bank and a credit union?
- How to choose a bank
- How to use your bank accounts
Most banking account discussions refer to the term “interest” because it’s usually at the center of people’s decisions on where to put their money.
“Interest” is a critical term to understand before you open any bank account because it’s what determines how much your money will grow over time.
Regarding a bank account, interest is the amount of money the bank pays you to keep your money in an account with them.
Interest earns you money. It means that while your money is sitting in an account, it’s making more money for you.
For example, if your bank pays .05% annual interest on a savings account, here’s how much you can earn in one year:
- Keep $100 in your savings account for one year and earn one penny.
- Keep $1,000 in your savings account for one year and earn ten cents.
- Keep $10,000 in your savings account for one year and earn one dollar.
However, if you shop around, you may find a bank that’s willing to pay .50% interest instead of .05% on your savings account.
Higher interest rates mean your money can earn much more.
By choosing a bank that pays .50% interest instead of .05%, here’s what you’ll earn:
- Keep $100 in your savings account for one year and earn fifty cents instead of one cent.
- Keep $1,000 in your savings account for one year and earn five dollars instead of ten cents.
- Keep $10,000 in your savings account for one year and earn fifty dollars instead of one dollar.
Higher interest rates mean that your money will grow faster, and when you begin saving thousands of dollars over the course of many years, those interest payments can really add up.
Savings accounts are just one example of how your money can earn money in a bank account.
Each type of account provides a different interest rate:
- Average interest on a savings account: .04%
- Average interest on a checking account: .03%
- Average interest on a money market account: .06 %
- Average interest on a 5-year certificate of deposit (CD): .32%
The interest rates above reflect savings accounts, but your money can earn much more if you know where to put it. For example, opening an account at an online bank instead of a brick-and-mortar bank allows you to earn .50% interest or more on a savings account.
That’s because online banks can cut more costs than traditional brick-and-mortar locations, because they have no overhead. Things like heating, cooling, electricity, and other building fees don't affect online banks because everything is done using the internet, which intrun, allows these institutions to pay their members a higher interest rate.
Or, if you already have an emergency fund equal to six months of living expenses, you could put your money into stock market investments and potentially earn an average of 9.2% per year.
The stock market is an investment, though, not a bank account. Investments carry risk, whereas bank accounts are a safe, secure place to store your money.
Eventually, you’ll want to put a portion of your income into investments, and we’ll show you how to do that later in this series. First, you want to get set up with a basic bank account.
Even though banks are a secure place to store your savings, there is a downside.
Leaving too much money in a bank account for many years is guaranteed to lose you money because bank accounts don’t earn enough interest to keep up with the rising costs of living (“inflation”) over time.
Bank accounts do serve an essential purpose, though.
They are the best and safest place to put your emergency fund. An emergency fund is an amount of money you set aside for emergencies such as a car breakdown, loss of job or income, or other unexpected financial crisis.
Interest is a percentage amount that a bank pays you to store your money with them. You can earn much higher interest rates when you put your money into investments instead of a bank account, but all investments come with risk.
Your money (up to $250,000) is safe in a deposit account (checking, savings, money market, or CD) as long as it’s in an FDIC-insured bank.
The FDIC insures up to $250,000 per depositor, per insured bank, for each account ownership category.
No depositor has ever lost money from an FDIC-insured bank account since the FDIC was established in 1933.
This means that if you put your money into a deposit account at an FDIC-insured bank, and the bank closes without returning your money, the FDIC will reimburse you, usually within a few days after the bank closes.
It’s uncommon for a U.S. bank to not be FDIC insured, but there are a few. For example, the Bank of North Dakota is state-run and insured by the state instead of the FDIC.
Most banks are FDIC insured, but you should always check before opening an account.
What Is The FDIC?
FDIC stands for the Federal Deposit Insurance Corporation.
It is an independent U.S. government corporation that was created in 1933 under the Glass-Steagall Act, otherwise known as the Banking Act of 1933.
The FDIC was created to ensure that people don’t lose the money in their accounts if a bank should fail or go bankrupt.
Why The FDIC Exists Today
The FDIC was established after many banks collapsed during the Great Depression, which is the worst economic catastrophe in United States history.
The Great Depression started as a recession set off by the stock market crash of 1929.
After the stock market crashed, people got nervous and began pulling their investments out of the economy. At the same time, people were spending less money, and many were going bankrupt.
As the economy worsened, people began to lose faith in the banking system, and depositors began pulling their money out of banks in masses.
“Bank runs,” when a large number of depositors panicked, and all pulled their money out of a bank at the same time, became a common occurrence, causing many banks to run out of money and go bankrupt.
By the time the Great Depression was over, 9,000 banks had gone out of business, and 9 million savings accounts had been wiped out.
When President Roosevelt took office in 1933, he ordered all banks closed for a “banking holiday” until they could be inspected and determined financially sound by Federal auditors.
Shortly after, Roosevelt signed the Banking Act of 1933, which helped to establish the FDIC.
Today, banks are a safe place to store your money.
People are no longer at risk of losing their savings should the economy collapse because their money is insured through the FDIC, thanks to the changes made after the Great Depression.
A mattress is a terrible place to store your money. Your home could catch fire or get burglarized, and you’d lose everything you have saved.
Plus, your cash earns no interest at all when it’s sitting in your home.
A bank is the safest place to store your savings. However, it doesn’t hurt to keep a few dollars in cash or money order at home in case you ever lose temporary access to your bank account.
For example, if your bank’s computers go down or if something goes wrong with their system, it could prevent you from withdrawing money from the ATM or using your debit card for a few hours or even overnight.
This isn’t a common occurrence, but it can (and has) happened.
Keeping your money in a bank is much wiser (and safer) than keeping a pile of cash in your home, but it’s a good idea to keep a few dollars cash handy in case you temporarily lose access to your bank account.
In this section, we review banking basics such as how to get paid, use an ATM, and write a paper check.
Getting Paid By Employers
Employers typically pay employees in one of two ways, either by paper check or direct deposit.
In most cases, you need a bank account to receive payment unless you want to pay high fees to cash your check at a 3rd-party check cashing service (not recommended).
Getting Paid With Paper Checks: How It Works
Companies that pay with paper checks either distribute them manually to employees on payday or mail them to their address.
When you receive a paper check, you can deposit it by:
- Going into your bank to deposit the check.
- Depositing the check through an ATM.
- Depositing the check digitally, if your bank allows.
Paper checks often take 1 – 3 days to “clear” your bank, meaning you may not have the money available to you until the waiting period is over.
Out-of-state checks can take even longer.
If your bank does require a waiting period, you should know that depositing a check on a Friday might not register until Tuesday, so your waiting period would start on Tuesday.
Different banks, and different types of bank accounts, have different policies and restrictions. To find out exactly how deposits and waiting periods work, ask your bank. Always be sure to figure in a couple of extra days beyond what the bank tells you, in case of delays, errors, or holidays.
Always save your bank deposit receipts, whether you’re depositing a check or cash.
Bank tellers are human, and chances are that at some point in your life, you’ll experience a banking error.
If you keep your deposit receipts, you’re nearly guaranteed to get the error correctly quickly. Without a receipt, you may have no way of proving that you deposited funds, which could lead to long delays or even loss of funds.
Getting Paid With Direct Deposit: How It Works
If your employer offers direct deposit and you already have a bank account, it’s much easier and quicker than paper checks.
With direct deposit, you sign an authorization form from your employer (or from your bank) that allows them to pay you electronically. When you get paid, the money is automatically transferred into your bank account, and the funds are available to you immediately. Unlike paper checks, there is no waiting period once it’s deposited.
You can even have your checks deposited into multiple bank accounts, which can save you time and effort if you need to divide your income for some reason.
Direct deposits are a secure process, and it’s much safer than a paper check because it doesn’t get lost and your banking information isn’t shared (such as the information that’s printed on your checks, often passing through several people before the deposit is complete.
You may find that the direct deposit amount doesn’t show up in your bank until two or three days after payday, or after your co-workers get their paper checks. This isn’t always the case, but your employer can let you know in advance what days the funds are typically transferred.
Overall, direct deposit is quicker, simpler, and more secure than paper checks, making it the favorite way for most employees to get paid.
Where your employer pays you by check or direct deposit, you should always plan on a 2-3 day delay between payday and the day your funds are available as cash.
Getting Paid As A Freelancer
Freelancers set up payment terms with clients in advance.
If the freelancer works through an agency or accepts direct credit card payments, then payments go through the agency or credit card processing company first.
If you’re a freelancer, there are several ways to get money from your client, agency, or credit card processor into your account:
- Direct transfer to your bank account
- Deposit to Paypal, Zelle, Venmo, or similar payment app
- Paper check
How you get paid as a freelancer often depends on how the client, agency, or payment processor prefers to pay you.
- Freelancers who work through Upwork have several choices on how to receive their funds, including through Paypal, direct transfer, or a service called Instant Pay For Freelancers.
- Freelancers who work directly for clients, without an agency or credit card processor, often choose to get paid through Paypal because it’s so easy and accessible. When a client pays you through Paypal, the funds are typically available immediately, and you can transfer them to your regular bank debit card instantly or use a Paypal debit card (if yours is a business account) just as you would any other bank card. Apps such as Zelle and Venmo work similarly, are also popular ways for freelancers to get paid. Direct transfer is a fast and easy way to get paid and doesn’t usually cost the freelancer any service fees. Direct transfers require a bit of paperwork and wait time to get set up, however, so they are best used for long-term clients who make regular payments.
- Freelancers who accept credit card payments must use a credit card processing company. The processing company takes the money from payors, then turns around and makes payments to the freelancer, typically using one of the methods above.
There’s almost always a fee required to get paid, paid by you or the client, or both. For many payment methods, the fee is nominal ($1 – $2), but some services (such as Paypal) charge between 1 – 3% to the freelancer and client. Direct transfers are typically free to the recipient.
If you get paid through an agency, credit card processor or payment service such as Paypal, your deposits are almost always subject to reversal if the client requests a refund.
As a freelancer, your first priority is to ensure that your client is happy with your work and in agreement on the payment amount. Otherwise, the money can often be taken back out of your bank account without warning.
Payment processors, agencies, payments services, and banks all have their own policies, so please check with yours on waiting periods, requirements, and fees.
How To Access And Spend Your Money
Eventually, your paycheck or freelance earnings make their way to your bank account, usually your main checking account.
Great! Now, how do you spend all that money you just earned?
First things first — pay your bills, savings, and (if you have them) investment accounts!
- For example, if your monthly spending budget includes rent, utilities, savings, and investments, you can set up automatic payments for all of them. Then, on the day that you specify each month, money will automatically transfer from your bank account to those companies.
All bills paid on time, every month – and you never have to lift a finger! Fantastic, right?
Yes, automatic payments are fabulous, as long as you get paid on time every month, for the amount you’re expecting.
However, if you have automatic payments set up but your paycheck doesn’t come through on time, or it ends up being less than what you expected, you could have some problems.
If the money isn’t in your account when it’s time for automatic payments, you’ll usually have a hold put on your account. This means that any money you deposit goes straight to those payments — usually before you can get any cash out.
Additionally, most banks charge fees if you overdraw your account, and those fees can really add up over time. Even just one $35 overdraft fee can hit you hard if you don’t get paid what you were expecting in the first place.
So, as you start to get paid from your job, check with your manager or HR representative to see what days you’ll be getting paid each month. You'll then want to make sure that you set enough cash aside ahead of time so that your bills are paid on time.
ATMs And Bank Debit Cards
Most banks give you a “debit card” that you can use for spending the money that’s in your checking account.
Think of it like an extension of your bank account – All of the money that you have in your bank account can be accessed through this plastic card. This means you don’t need to keep stacks of physical paper money on your for every purchase you make.
More commonly, people use debit cards to make online and in-person purchases for goods and services.
A debit card also allows you to take cash out of an ATM, which stands for Automated teller machine.
ATMs are basically an extension of your bank, so instead of walking into a specific bank location to deposit or withdraw money, you can go to an ATM.
And there are thousands of ATMs located throughout the US, so even if you’re hundreds of miles from your bank or credit union, you can still safely deposit or withdraw money from your bank account.
You can do this by inserting your debit card into the ATM. The machine will then ask for some sort of identification from you like your 4-digit PIN, or personal identification number.
Just keep in mind that some ATMs will charge you fees for using them if you are not a member of the bank or credit union in which the machine is owned.
These fees can vary and usually charge you around $1-$3 for using the machine, regardless of the amount that you’re withdrawing or depositing.
In some cases, usually for larger purchases, you may be required to issue an electronic or paper check instead of using your bank card.
Paper checks are usually provided by your bank when you open an account. You’ll also have the option to order personalized checks at the time you open your account.
If you make digital payments for most things, it may not be worth spending $10 – $20 to order extra checks, since a handful of them may sit unused for quite some time.
To write a check by hand, you’ll fill out the following information:
- Amount, written out in words (such as Four Hundred and Fifty Two Dollars and Zero cents)
- Your signature
Electronic checks are requested by some payors, although you often don’t get any purchase protection with electronic checks.
Additionally, you’ll be sharing your bank account number with the payee, so be sure you only send electronic checks to people or companies that you trust.
Electronic checks require you to write in your bank account number, which you can find at the bottom of your paper checks.
What the numbers on the bottom of your checks mean:
There are 3 sets of numbers on every paper check:
- First set of (3) numbers: This is your bank’s routing number. The routing number identifies your bank.
- Second set of numbers: This is your personal bank account number, the one you’ll use when writing an electronic check.
- Third set of (3) numbers: this is your check number, which is different on each check that you write. Reference this number in your checkbook when recording how much you spent.
Direct deposit is the easiest way for employees to get paid, but some employers still issue paper checks.
Typically, you’ll store your spending money in a checking account, then use automatic payments and bank cards to spend it. On rare occasions, you may pay by paper or electronic check.
There are four basic types of bank “deposit” accounts for storing your money: checking, savings, money market, and certificate of deposit.
Most banks provide a wide variety of every account type, each with its own terms and conditions.
For example, one checking account option might not require a minimum balance, but they charge a $15 monthly account fee.
Another checking account option at the same bank might give you free checking (no monthly fee) as long as you keep a $1,000 balance at all times.
There are so many bank account variables that the options can easily overwhelm a beginner.
If you allow yourself to become overwhelmed with banking options, though, you put yourself at risk of allowing a banker to make decisions for you.
Bankers are salespeople who typically make recommendations based on what’s best for the bank, not for your pocketbook.
In some cases, banks have committed fraud by intentionally misleading customers with poor recommendations.
To avoid becoming overwhelmed or making decisions you may regret later:
- Understand the different account types before you open an account.
- Determine what type of bank account(s) you want to open before you visit the bank.
- Personally read the terms and conditions of the account before signing anything.
Below, we explain the four different types of bank deposit accounts, but please review the terms and conditions of your bank before you make a decision. Terms and conditions differ from bank to bank and may include unique restrictions, fees, and requirements.
What Is A Savings Account?
A savings account is the most basic type of bank account. It’s where you deposit money to save it, and you can typically withdraw your funds at any time. Many savings accounts are subject to a minimum opening deposit (typically $100 or more), which means you cannot open an account unless you have that amount in hand on the day you open it.
Savings accounts are exactly what they sound like — a place to save your money — and are an excellent place to store your emergency savings.
How Much Money Should You Put In A Savings Account?
Growing up, many of us were taught to always put a portion of our paychecks into a savings account. Money in your savings meant you were financially well-off, so you should grow that savings as big as possible.
Today’s economy works differently from the ones our parents and grandparents experienced.
In today’s world, if you put all your money into a savings account and leave it there, it loses its value over time due to inflation.
- Inflation is the rate at which the cost of living, including goods and services, increases over time. For example, in 1980, you could purchase a Marvel comic book for 40 cents, but in 1990 the same comic book would have cost you one dollar. By 2005, a Marvel comic book cost $2.25.
The interest your money earns in a typical savings account can’t keep up with the cost of inflation.
For example, in 2018-2019, the average inflation rate was 1.76%, but the average savings account interest rate was only .09%. So, if your money earned 1% interest in a savings account during those years, you lost .76% of its value.
The average inflation rate, most years, is roughly 2%. However, it can spike much higher:
- 2021 forecasted inflation rate: 2.5%
- 2008 inflation rate: 3.84%
- 1990 inflation rate: 5.4%
Because inflation devalues your cash and savings accounts don’t pay enough interest to keep up with it, you could go broke by allowing your money to remain in a savings account throughout your lifetime.
That’s why saving strategically is critical to building financial stability.
What Is Strategic Savings?
Saving strategically involves using a bank account for some of your savings, then funneling the rest into investments that return enough interest to beat the costs of inflation.
The first step in strategic savings is to build a short-term savings of $2,000 in case of a minor financial crisis.
For example, if your car breaks down and you have no other way to get to school or work, it can derail all of your plans and take years to recover.
Or, if you need a quick $1,500 for medical reasons but don’t have it, you run the risk of doing long-term damage to your health.
Putting $2,000 aside for emergencies should be your top priority when you’re starting out as an adult (or starting over) because it may save you from a crisis that could otherwise affect your future.
If $2,000 seems impossible to save, consider cutting back on your living expenses or picking up an extra job to help you save up for it as quickly as possible.
The second step in strategic savings is to build on your savings account, over time, until you’ve saved the equivalent of six months’ living expenses.
As you move through life, bigger financial emergencies may arise.
The pandemic is an excellent example of why a full emergency savings is critical to your financial health. Many people lost their jobs overnight, without warning, and had to find ways to survive without an income for months.
For those with a full emergency savings, the financial stress of the pandemic was less painful. Still, many people who had racked up debt without saving money before the country’s shutdown landed themselves in a severe bind.
We may not ever experience a pandemic like Covid again in our lifetimes, but other emergencies can arise. For example, you could lose a job or need to take time off work for medical reasons or to care for a family member.
Many of the difficult things that can happen in life involve losing income in one way or another. But when you have a complete savings account, it can help ease those challenges and allow you to focus on addressing them in the best way possible.
Additionally, the financial protection provided by a full emergency savings account removes much of the fear and stress people expend worrying about bad things that might happen “someday.”
Building a full emergency savings account equal to six months of living expenses is like self-insuring against a personal financial crisis.
Once you have your short-term emergency savings ($2,000) in place, you can build your entire emergency savings account over time by setting aside a portion of your income each payday.
As you’re building your full emergency savings account, you also want to begin putting a small portion of your income aside for investments.
Later in this series, we’ll dive into how you can allocate your paychecks in a way that allows you to balance both savings and investments.
A savings account at a bank is the best place to store your emergency savings.
Even though your cash loses money while sitting in a bank, you still need a safe, secure place to store your savings.
Keeping your savings in a bank will cost you a bit over time, but it’s worth the investment when it comes to your emergency savings.
Once you’ve put six months of living expenses aside, you should begin to channel your money into investments that pay higher interest rates than you can get with a bank account. We’ll explain your investment options later in this series when we cover investments.
What Is A Checking Account?
Checking accounts are meant to hold your spending money.
Once you deposit money into a checking account, you can use that money to make purchases with a debit card, paper check, electronic check, or bank transfer.
Checking accounts are an excellent place to keep your spending money, but they can also get you in trouble if you become careless with how you use your dollars.
A savings account is a great way to store your money, but the only way to actually spend your money is to move it to a checking account.
Think of it this way – Your money is fluid in a checking account; dollars come in and dollars go out. But in a savings account, your money is stable; your dollars won’t move unless you specifically request that they’re moved.
How Do You Get In Trouble With A Checking Account?
You can get in trouble with a checking account by spending more than you deposit.
For example, if your checking account has a balance of $500 and you spend $550 using a combination of debit cards and checks, you will “overdraw” your account. When you overdraw your account, you incur a hefty fee, often $35-$40 or more, on each transaction it affects.
So, if you have a balance of $1,000 in your account and you mistakenly rack up transactions totaling $1,025, the $25 difference can get quite expensive.
For example, imagine your $25 mistaken overdraft consists of several transactions, such as $10 at a restaurant, $7 at the dry cleaners, $5 at the coffee shop, and $3 for a pack of gum at the convenience store.
Each of the transactions that process after you’ve surpassed your balance costs the same — usually about $35-$40 per transaction.
If your bank charges $35 per overdraft (some charge more), you end up paying $140 in fees for $25 worth of goods.
- By the time it’s done, you’ve paid $38 for a pack of gum, $40 for a cup of coffee, $42 to dry-clean one shirt, and $45 for a drive-through sandwich.
The hassle doesn’t end there because you also have to apologize and make reparations for any checks that your bank didn’t cover for you (sometimes they do, sometimes they don’t).
Some banks may automatically use what you have in your savings account in order to cover missing funds in your checking, but this can rack up fees too & can put your savings at additional risk.
Make sure to look into each individual bank's policies on overdrafts, as they will likely differ by institution.
Additionally, if you’re short on cash, you can quickly get buried in debt as new charges come through for your utilities, phone, etc. If you don’t replace the $25 overdraw PLUS bank charges, you’ll still have no money in your account to pay the bills. If your bills are on autopay and try to clear your bank before the balance is replenished, you could again get charged more overdraft fees.
Overdraft situations are handled differently with each bank and can often be unpredictable. Sometimes banks will simply decline your debit card or cover a check you’ve written, while other times, they might kick it all back and rack up the charges.
Here’s the good news: your checking account should never get overdrawn if you’re responsible with your money.
The following five steps will ensure that you never experience overdraft nightmares:
- Keep close track of every transaction you make, including deposits, checks, debit card purchases, and transfers.
- Remember to add any of the bank’s monthly service fees into your expenditures.
- Keep a couple of hundred extra dollars in your account at all times.
- Don’t spend more than what you’ve deposited.
It’s super-easy to keep track of all your checking account transactions, but many people get buried in debt because they don’t take the time to do it.
Most banks are happy to charge you outrageous fees if you make mistakes or overdraw your account.
However, you can’t blame banks for charging outrageous fines on overdrafts when the terms and conditions are made clear from the start — and you agreed to them in writing.
When Twitter user @katmauvearts complained about banks collecting $30 billion in overdraft fees, @realitybypamela provided a brutally honest response:
“The banks have some bad policies for sure. However, many people are simply irresponsible…They either don’t understand the policies or they are in the wrong type of account.”
Understanding your account terms and managing your checking account properly is part of the financial and legal responsibilities that come with opening a bank account.
Why You Should Think Twice Before Connecting Your Savings To Checking For Overdraft Protection
If you never get sloppy with your checking account, you’ll never need overdraft protection.
However, most bankers push you to agree to overdraft protection, which means that you authorize your bank to dip into your savings account if your checking account is ever overdrawn.
Let’s assume you take good care of your checking account, and keep track of all your deposits and expenditures so that you never overdraft your checking account.
In this case, the only reason your account would overdraft is if there is some type of fraud or outrageously unfair charge or mistake involved.
If your checking account somehow gets hacked or defrauded, do you really want to allow the fraudsters to help themselves to your savings account as well? No.
If you’re careful with your private information and who has access to your checks or debit cards, your chances of fraud are low, but vendor mistakes are not uncommon.
And even though fraud won’t happen to everyone, you don’t want to ignore the fact that scammers, including robocalls, are actively working (often full-time from all ends of the globe) to try and obtain your bank account information so they can steal money from you.
Scammers aren’t the only way your account can become compromised.
What if your favorite Starbucks barista accidentally charges you $5,700 instead of $5.70?
Or, what if, like many Texans in 2020, you’re charged $10,000 – $15,000 for one month of electricity (instead of the usual $200) — and you have your utility bills on autopay!?!
While there is usually recourse (and a refund) for these types of mistakes or fraud, it can sometimes take months to recover your money. However, if you don’t grant access to your savings account, then it won’t affect the bulk of your money.
Overdraft protection that connects your checking and savings account can put your savings account at risk. If you are diligent about tracking your spending and deposits, you will never need overdraft protection anyway.
How Much Money Should You Keep In A Checking Account?
You should only keep what you need in your checking account, plus a couple of hundred extra to pad your account in case of an accounting error on your part.
So, if you usually spend $2500 a month, put $3000 into your checking account and leave the rest in your savings or another type of deposit or investment account.
When it comes to checking accounts, deposit only what you think you’ll spend for the month plus a couple hundred in padding, keep careful written track of your balance, and don’t allow bankers to connect to your savings for overdraft protection.
What Is A Money Market Account?
A money market account is another type of deposit account you can get at a bank.
Money market accounts provide slightly higher interest rates than a checking or savings but come with more restrictions.
Money market accounts (MMAs) allow you to write checks and use debit cards and ATMs to access your money. Like a typical bank account, MMAs are insured through the FDIC (when you open them at FDIC insured banks), so your funds are safe up to $250,000.
The advantage of money market accounts is that many offer higher interest rates (up to .60%) than a standard checking or savings account. However, many impose tougher restrictions such as:
- Minimum balance required to earn the highest interest rates (sometimes as much as $100,000)
- Limited use of free services; many MMAs charge fees for using checks and out-of-network ATMs or restrict you to a specific number of transactions per month.
While MMAs can offer slightly higher interest rates than a standard savings or checking account, it’s still not enough to keep up with the cost of inflation.
Ultimately, your money gets devalued over time when it sits in a money market account, just as it does in a regular savings or checking account.
Given the restrictions and fees imposed by MMAs, a checking account is more likely to serve your needs better than a money market account.
As your savings account grows, it might hold enough to justify the slightly higher interest earned with a money market account. Before you consider putting your emergency savings into an MMA, please check the terms carefully and understand how much money you need to save to earn the higher interest rates.
What Is A Certificate Of Deposit (CD)?
A certificate of deposit is another savings option that offers much higher interest rates (often 2-3%) than other bank accounts but also restricts access to your funds.
In exchange for earning higher interest on your money, you agree to let the bank keep it for a period of time — usually six months, one year, or five years. Throughout the term of your CD, you cannot withdraw your funds without incurring penalties.
CDs are helpful to banks because they give them more cash, which allows them to lend money to other people and earn more profits. In exchange, they pay you a higher interest rate.
Certificates of Deposit are insured by the FDIC (as long as you get them at an FDIC insured bank), so your money is secure up to $250,000.
The problem with CDs is that if you have to withdraw your money early in case of an emergency, you’ll get hit with penalties that affect the principal amount you deposited — and the Federal government has no cap on the amount of penalties a bank can charge you.
Withdrawing a CD early means you might end up with less money than you started with.
CDs are not a good place to store your emergency savings because you need access to those funds if a crisis hits.
And, while CDs offer higher interest rates than a savings account, when you’re ready to invest, you’re better off to consider putting your money into the stock market or real estate for even better returns.
Banks and credit unions are alike in the services they offer. Both banks and credit unions offer checking, savings, and money market accounts, as well as CDs. Their interest rates are similar; although some people claim your money will earn more in a credit union, that’s not always the case.
The main difference between credit unions and banks is that banks are for-profit, and credit unions are not-for-profit.
Credit unions are owned by their members and set up as a cooperative. Most credit unions serve a specific community of people, such as their faith, professional industry, or local community.
Instead of the FDIC, credit union deposits (into federal credit unions) are insured by The National Credit Union Share Insurance Fund, which protects individual accounts for up to $250,000 and their interest in joint accounts combined up to $250,000.
Most credit unions are exempt from taxes and receive subsidies from affiliate organizations, so they don’t have to focus on making profits for shareholders. As a result, they strive to provide customers with the best possible interest rates, lower fees, and better service.
Banks are for-profit institutions that focus on earning money first. Compared to credit unions, you’ll find that most banks charge higher fees and often pay less interest.
Pros And Cons Of Credit Unions
Credit unions exist to serve their customers, but that doesn’t always mean that a credit union is the best option for you.
Consider the pros and cons of banks and credit unions before deciding where to open your bank account.
Credit Union Pros:
- Sometimes better interest rates on checking or savings accounts
- Often provide lower interest rates on loans
- Lower eligibility requirements
Credit Union Cons:
- Fewer locations
- Possibly less access to ATMs
- Must belong to the industry or organization affiliated with the credit union to join
Bank Account Pros:
- Significant conveniences such as online banking tools and massive ATM networks
Bank Account Cons:
- Higher fees
- Stricter eligibility requirements
If there’s a credit union nearby that you are eligible to join, you might want to check it out before opening an account at a regular bank. Compare its benefits to your local banks to determine if a credit union is the best choice for you.
If you travel a lot and need access to ATMs or bankers when you travel, your best choice will likely be a major bank for its convenience and accessibility.
When it comes to choosing a bank or credit union, there are five things you should look for:
- FDIC insured: To find out whether a bank is insured, look for “FDIC insured” on the bank’s signage or masthead, or ask your banker. FDIC-insured banks guarantee that you won’t lose your money (up to $250,000) if the bank goes out of business or bankrupt.
- A good reputation: Look for reviews, ratings, and awards to determine the reputation of the banks you’re considering.
- Zero monthly maintenance fees on your savings account. Paying monthly fees for a bank to hold your money is a waste of your income, and it adds up over time. Even a $10 monthly fee will add up to $600 over the course of five years. Instead, pick up the phone and call around to find a bank that won’t charge you any monthly fees. While you’re comparing fees and rates, take the time to check out a couple of online banks. Online banks don’t have the overhead that brick-and-mortar banks do. As a result, they frequently offer higher interest rates and zero-fee savings accounts.
- Higher-than-average interest rates: Check the terms and conditions of the bank’s accounts to find the best possible interest rates for your savings account. Ask whether there’s a minimum balance required to receive the highest interest rate.A bank account won’t pay you enough interest to keep up with the rising costs of inflation, but the higher interest rates you get, the less money you’ll lose over time.
- Easy access to your information: Choose a bank that allows you (free) access to online banking, so you can check your transactions and balance anytime.Online banking can help you ensure that you haven’t made any accounting mistakes, and checking your online transactions frequently helps prevent fraud.
If you’re considering banking at a credit union or small bank, please take into account whether the bank can provide you with conveniences such as easy access to ATMs when traveling.
Look for a reliable, trustworthy bank that pays the highest interest rates on your savings, charges no fees for savings, and charges zero or very low fees on checking accounts.
Once you understand how bank accounts work, using them to store your money is simple.
Use your savings account to build your emergency savings. Begin with a $2,000 short-term emergency savings, then gradually build your way up to savings six months of living expenses.
Use your checking account for spending. Be responsible with your checking account, and track all of your transactions so you always know your balance.
Along the way, you’ll want to learn how to invest your money in ways that can provide higher interest rates than a bank account. Once you put $2,000 in your savings account, you’ll also want to begin allocating a portion of your income toward investments.
Later in this series, we’ll walk you through how to allocate your income for savings and investments, and show you how to invest your money in ways that allow it to grow significantly over time.
Get To Know Banking Before You Open Your First Account
Before you open your first bank account, take time to understand the basic banking terms and accounts covered above.
Look for the best interest rate on a savings account, and the lowest fees on a checking account.
You may find better rates and more helpful service at a credit union, but you should consider whether it provides easy access to your cash when you need it.
Researching banks and account terms and conditions is part of managing your money responsibly, and the first step toward a healthy financial future.