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While stashing your cash under your mattress is always an option, most people take a different approach.
Nearly 95% of American households are “banked,” meaning at least one member of the household had a checking or savings account, according to 2019 figures from the Federal Deposit Insurance Company (FDIC), the government agency that insures bank deposits.
But just because most people use a bank, it doesn’t mean they know everything about how banks work — and it doesn’t mean they have the right banking partner for them.
Many people stick with the same institution their whole lives just because it’s familiar, even if that institution pays practically nothing in interest or doesn’t offer the right services for them.
So take a look around: With the right info, you can make sure your cash is hustling for you instead of hiding under the sheets all day.
What is banking?
Simply put, banking refers to the business that financial institutions carry out and the services they offer. Those institutions are designed to manage consumers’ cash and borrowing transactions, among other things.
Types of bank accounts
Getting the most out of your bank account is a lot easier when you know your options.
Here are five of the most common types of accounts, which most banks and credit unions offer to help people manage spending, minimize fees and reach their savings goals.
CDs are more rewarding than checking or savings accounts, but you’ll have to kiss your money goodbye for a while.
These accounts have a fixed interest rate and a preset date of withdrawal, which is called the maturity date. Premature withdrawals will face a penalty.
The term length can be anywhere from a few months to 10 years. The longer it is, though, the more you’ll earn.
The great thing about CDs is their rates can be significantly higher than interest rates on savings accounts and there are usually no fees. The funds are insured, the rates are locked in, and the returns are guaranteed.
However, withdrawing money early could prove very costly, and CD rates don’t always keep up with inflation.
MMAs pay slightly higher interest rates than ordinary savings accounts.
They’re a holdover from a time when the federal government capped the amount of interest banks could offer on their standard products.
Many MMAs also offer conveniences like debit cards and personal checks.
But they’re also less flexible than other types of accounts. Minimum deposit and balance requirements tend to be high, you’ll be limited on how often you can withdraw funds, and MMA rates fluctuate, so there are no guarantees.
As a result, they’re not always the best option for long-term investment and may be better suited for short-term goals like building an emergency fund or saving for a big purchase.
5. Retirement accounts
Two words sum up the appeal of retirement accounts: tax savings.
The Roth individual retirement account, or Roth IRA, is a popular choice offered by banks.
You can’t deduct contributions from your taxes, like you can with a traditional IRA. However, your withdrawals — including your investment earnings — will be tax-free in retirement.
And, through the miracle of compound interest, the earnings can be a beautiful thing.
Let’s say that starting at age 20, you contributed $5,000 a year to a Roth IRA, and let's assume the investments grow by an average 8% each year. Your savings would balloon to more than $2 million by the time you reached 65.
The Roth IRA does have limits on how much you can earn to be eligible. And you’ll pay steep penalties for withdrawing funds before retirement age.
Before opening an account, you may want to talk over your circumstances with an expert for advice on the best way to save. The IRS website also offers a wealth of information on retirement accounts and how they’re taxed, so do your homework.
Credit unions vs. banks
Deciding where to store your money is a big decision. Typically, your choice will come down to either a bank or a credit union.
Oftentimes, we choose a bank or credit union as young adults based on family recommendations. But just because a certain financial institution worked well for your parents doesn't mean it's the best fit for you.
Let’s explore the characteristics of each to help determine which is the better choice for your needs.
What is a credit union?
A credit union is a not-for-profit financial institution owned by its members. Since credit unions don't need to show a profit, their sole purpose is to offer their members the best rates possible.
Credit unions are smaller than banks and limit membership to certain groups of people. They might all be employees of the same company, followers of a specific religion, residents in a certain geographic location or members of a civic organization.
As a member, you can vote on your credit union’s policies and influence how it’s run.
What is a bank?
Banks are for-profit organizations owned by investors. The main goal of a bank is to make money for the investors — and unlike with a credit union, you’re not a bank "member," which means you have no say in bank policies.
Banks don’t restrict eligibility to certain groups of people. Anyone who lives in a bank's serviceable area can open an account and become a customer.
Banks can be broken down into online-only operations and brick-and-mortar institutions. Online banks are completely virtual and have few or no physical locations. While they can’t offer face-to-face service like brick-and-mortar banks, their lower overhead typically allows them to offer better rates.
Pros and cons of credit unions
Favorable interest rates. Since credit unions aren’t designed to make a profit, they typically offer higher interest rates on deposits and lower rates on loans.
Lower or no fees. The nonprofit nature of credit unions allows them to keep fees as low as possible. For example, unlike banks, many credit union checking accounts have no minimum balance requirements or monthly maintenance fees.
Better customer service. Credit unions prioritize community and personal attention. Since policies are voted on by members, you’re more likely to receive services tailored to your needs. You can also develop a personal relationship with branch managers and loan decision-makers, which may help you secure a loan.
Security. Credit union accounts are insured up to $250,000 by the National Credit Union Administration. If you need higher coverage limits, you can often open multiple accounts.
Outdated technology. Since the goal of credit unions is to charge you as little money as possible, they may have less of a budget to roll out new apps and technology.
Less locations. Credit unions are smaller and more focused on a tight-knit community. That means there are naturally fewer branches and ATM locations. Many credit unions have joined forces to create the CO-OP Shared Branch and ATM network that allows members to use branches and ATMs in the co-op nationwide.
More restrictive membership. Each credit union has specific membership eligibility requirements. That said, nowadays larger national credit unions only require you to be part of certain easy-to-join organizations.
Limited financial products. Most credit unions offer checking accounts, savings accounts, CDs, basic credit cards and various loans. But they don’t typically offer the wide array of financial products you find at banks.
Pros and cons of banks
More accessibility. Big banks offer more branches and ATMs than credit unions. For example, Chase has more than 4,700 branches and 16,000 ATMs — making it more convenient to access your money wherever you are. And while some small regional banks require you to live in the same state, most banks don’t have special eligibility requirements to join.
More financial products. Banks are more likely to offer money market accounts, investment accounts, wealth management services and a wider range of credit card options.
Better technology. Banks have more funds to invest in fancy websites, convenient apps and other tech to make your life easier. Just remember, the money to develop this technology comes out of your pocket via higher fees and less favorable rates.
Higher fees. Since a bank’s main objective is to make money for its investors, they charge higher fees. For example, checking accounts often charge fees if you do not maintain a minimum balance in your account. Overdraft and bounced check fees are also often harsher in banks than credit unions — especially with non-premium accounts.
Worse rates. A bank’s for-profit objectives naturally lead to less favorable rates than credit unions. That said, you may find better rates at an online bank compared to a brick-and-mortar bank.
Less flexible. Banks have strict rules and protocols set nationally by a board of directors. This makes them less flexible than credit unions, where you have a say in the rules. This rigidity — paired with corporate, profit-focused policies — is a recipe for customer service issues.
How to open a bank account
Whether you’re one of the few unbanked Americans or you’re ready to find a new institution that suits you better, here’s what you need to consider:
First, figure out how you’ll use your bank account and which account type (or types) fits those habits.
Most Americans have at least one bank account, but you can have several — and at multiple institutions.
At minimum, you should have a checking account for making frequent purchases, depositing paychecks and taking care of bills. A savings account is a great option if you're looking to put some money aside.
But as we’ve already gone over, you may also opt to open a CD, MMA or a retirement savings account depending on your financial goals and priorities.
Because it’s such a crowded market, look for the bank that lines up the most with your priorities, whether that be low fees, a large national presence, variety of services, leading-edge digital offerings or an institution that reflects your values.
Once you’ve successfully chosen the type of institution you want to use, be prepared to provide some personal information to open your account, such as:
Photo ID, like a driver's license, Social Security card, passport or birth certificate
Personal information, including your date of birth, physical address and phone number
Proof of address, like a bill in your name
This isn’t an exhaustive list, and some banks require more information. But at minimum, those are the documents you’ll likely need.
When you open your first account, you may have to pay an initial deposit fee. It varies by institution and account type, but you’ll want to check with the bank in advance to make sure you have the right amount of cash.
When you’re ready to open your bank account, you’ll be asked to sign an agreement stating that you understand the rules and regulations regarding your account(s).
While reading through the fine print, look out for fees that might be attached to the account in different circumstances.
Some banks may charge a monthly fee if you don't maintain a minimum balance. It's easy enough to find an account without those pesky charges — but you've got to know where to look.
Not just a safe place for your money
Once you’ve found a financial institution that works for you and you’ve set up all your accounts, consider exploring everything else your bank or credit union has to offer.
Mortgages, lines of credit, loans and credit cards each give consumers a different way to access capital to make big purchases — from a house to the furniture you fill that house with — without having to have all the cash handy.
Of course, if you’re not careful with credit, you can end up in trouble — which is why it’s crucial to get familiar with interest rates.
Ask the eight ball
Want to learn more about the magical world of banking? Shake the sphere for eight financial facts.
You’ve probably heard this term before, even if you never fully understood what it means.
The prime rate is a key lending rate used to set many variable interest rates, such as the rates on credit cards and home equity lines of credit, or HELOCs. You might see a HELOC advertised as “prime+1%,” for example.
Banks typically take the Fed rate and add 3 percentage points to get their own prime rate. That’s the rate commercial banks offer their most creditworthy customers, like big corporations.
Borrowers with strong credit scores get closer to the prime rate, while those considered more likely to default — that is, not pay back a loan — get higher rates.
Get to know your 3-letter acronyms
Whether you’re comparing credit card offers, opening a new bank account or looking for a loan, it’s important to understand the three letters that may appear next to your interest rate.
APR means annual percentage rate, and APY means annual percentage yield. They're not the same thing. (And trust us, this APR and APY business isn't TMI, either.)
Banks or lenders will emphasize whichever of the two will seem more enticing to you, so it’s important to be able to tell the difference between these two terms.
APR vs. APY
When borrowing money, the annual percentage rate is what the loan costs you in interest and other expenses during one full year.
With credit cards, your APR is simply the interest rate.
But with a mortgage, your APR factors in not only the interest but also "discount points," broker fees, some closing costs and other charges.
Annual percentage yield is the rate of return a savings deposit or investment will earn over the course of 12 months.
APY includes compound interest — that is, interest earned by the interest itself — so it's an accurate way of calculating the growth of money kept in a savings vehicle or investing account.
U.S. banks must include APY when advertising interest-bearing accounts in order to give customers a true picture of what their money will earn in a year.
What it all boils down to
The major difference between APR and APY is that APR doesn’t take compound interest into account, but APY does.
APR is the annual or yearly rate of interest, without compound interest factored in. APY builds the compounding into the rate.
A savings vehicle or loan might have an APR of 5% but an APY of 5.09% if the interest is compounded quarterly, or an APY of 5.11% if the compounding is done monthly.
Banks tend to compound the interest on savings accounts on a monthly or daily basis, while mortgage interest is often compounded monthly.
A mortgage lender who's trying to get you to sign up for a home loan will make the interest rate sound as low as possible — which means you're more likely to be presented with an APR instead of the APY. Always ask what the APY is.
Meanwhile, when a bank wants your deposit for a savings account, you can expect to hear the savings APY upfront, because it will be higher and so will sound better than the APR.
As you evaluate loans and savings products, make sure you’re comparing APY to APY, or APR to APR, and consider the frequency of compounding.
This all may sound complicated, but all you have to do is remember: When interest is compounded more often, you'll earn — or pay — more.
Test your banking knowledge
Not all of the country’s big banks are headquartered in New York — can you guess the city where Bank of America has its HQ?
Answer: Charlotte, North Carolina
High-yield vs. traditional savings accounts
What’s so great about high-yield savings accounts?
As of October 2022, some accounts were offering around 3.11% — that’s almost 18 times more than a traditional savings account.
What's the catch? Often with a high-yield account, you need to make a certain minimum deposit, maintain a minimum balance or pay regular fees — though not necessarily.
The great thing about high-yield savings accounts is that they’re versatile; whether you’re planning for your wedding or preparing for retirement, you can rest easy knowing that the money you’re putting toward your goal is growing.
Some popular reasons for opening a high-yield savings account include emergency savings, planning for a vacation or other major expenses.
Running the numbers
Your interest rate may not seem like it’s making a big difference in your account balance at first, but over time you’ll find it starts adding up fast.
If you were to put $10,000 into a traditional savings account with a low APY — say, 0.01% — you’d only earn $1 in interest during an entire year.
Compare that to a high-yield savings account with a rate of 0.60%, which would earn you $60 in interest over the course of a year — quite a difference. And that’s without making any monthly deposits.
Let’s say you have $200 to contribute to savings every month.
Assuming your traditional savings account has a rate of 0.13% and you’re getting 2.0% on your high-yield savings account, here’s how much you’ll have in your account after a year, five years, 10 years and 35 years.
Sigrid’s current role is associate editor, and she has also worked as a reporter and staff writer on the Moneywise team.
In her time with the company, she’s written about everything from estate planning in your 20s to figuring out how much tile you need to renovate a bathroom. Regardless of the topic, Sigrid takes pride in demystifying complex financial issues and turning them into stories that help readers find the personal in personal finance topics.
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