With traditional passbook savings accounts paying only a little better now than next to nothing in interest, more and more individuals are looking for better-paying alternatives. Among them are money market accounts, other bank-account options and peer-to-peer lending. Here's what you need to know.
- With interest rates still hovering around historic lows, savers are hard-pressed to enjoy favorable interest rates on deposits kept with bank savings accounts.
- Several low-risk alternatives do exist that can boost the interest rate you receive.
- Here we look at five, including money market accounts and CDs at online banks.
1. Higher-Yield Money Market Accounts
One of the simplest alternatives to depositing money in a traditional passbook savings account is to obtain a money market account. Money market accounts are insured by the Federal Deposit Insurance Corporation (FDIC) just like regular savings or checking accounts.
In addition to paying higher interest rates than standard savings accounts, money market accounts offer limited checking account services. There is usually a relatively low maximum number of checks that a customer can write on his or her account per month—typically between five and 10. In return for abiding by this restricted withdrawal activity, money market account holders receive a higher interest rate than those that are available for traditional savings accounts. A bank offering only a 0.10% interest rate on standard savings accounts, for example, might offer a 0.25% interest rate on a money market account.
With passbook savings accounts paying so little, try to find a better place to stash your emergency fund—just watch for whether the money is still insured.
In addition to the limit on monthly transactions, money market accounts usually have other restrictions as well, such as a required minimum opening deposit amount or a minimum balance that must be maintained. If there is a minimum balance requirement and the account drops below the minimum, account holders may be paid just the standard, lower interest rate offered on regular savings accounts; however, some banks also charge a penalty fee. Before opening a money market or other alternative account, scrutinize the fine print of your agreement for any restrictions that apply to the account, along with all fees that the account may incur.
2. Certificates of Deposit
For individuals who do not expect to need access to their savings for at least a year or two, there are certificates of deposit (CDs). The longer the term that customers are willing to have their money tied up, the higher the interest rate available. One-year and two-year CDs offer higher interest rates than are currently available on traditional savings accounts. But the catch is your money will be locked up for the term of the CD - typically a few months top a few years. If you touch the money prior to that you may be subject to fees and penalties.
According to Bankrate.com. around 1% was the national average APY rate for a one-year CD (as of February 10, 2020); two-year CDs offered as high as 2.15%. However, Synchrony Bank and Marcus by Goldman Sachs were paying the highest rates, subject to a $500 minimum. With a little planning, individuals can spread their capital across CDs of varying term lengths to provide themselves with more liquidity, in case they need to access part of their savings. Even better, CDs are FDIC-insured. (For more, see Certificates of Deposit.)
3. Credit Unions and Online Banks
It's often possible to obtain a higher interest rate simply by moving a savings account to a different financial institution, either one down the street or one accessed through the internet. Credit unions operate much the same as banks, although they typically offer fewer financial services. Credit union accounts are federally insured through the National Credit Union Share Insurance Fund (NCUSIF), the credit union equivalent of the FDIC.
Credit unions commonly offer significantly better interest rates on savings accounts than banks do because credit unions are nonprofit organizations. An individual may be able to go from earning 0.09% to 1.75% or 1.80% simply by opening a savings account at a credit union rather than at a traditional bank.
Online banks, such as Ally Bank or American Express Bank, also typically offer higher interest rates on savings accounts. They are able to do this because they avoid the brick-and-mortar overhead expenses of maintaining physical branch offices. Moreover, these banks typically offer attractive rates on CDs, above those of brick & mortar banks.
4. High-Yield Checking Accounts
There are high-yield checking accounts that offer better interest rates than savings accounts. Some of these checking accounts offer up to 5.00% annual percentage yield on a promotional basis, in contrast to savings account rates of only 0.10%.
To obtain the higher interest rates, customers typically have to meet certain requirements, such as a minimum balance, establishing direct deposit or bill pay, or conducting a minimum number of monthly debit card transactions. If account holders fail to meet the requirements for receiving the higher rates, there's usually no penalty. They are simply charged the bank's standard lower rate for checking accounts.
5. Peer-to-Peer Lending Services
Peer-to-peer lending services, usually operated through websites, have become increasingly popular in recent years. Peer-to-peer lending provides a way for individuals looking to borrow money to obtain personal loans outside of going to a bank—and for individual lender investors to earn excellent returns on investment by funding the loans with their lending account deposits. Through websites such as Prosper.com, individuals on the lending side provide loan capital for individuals on the borrowing side.
Lending accounts with peer-to-peer lenders are not FDIC-insured like a savings account at a bank, and it is possible to lose money. However, the overwhelming majority of investors are able to consistently realize annual returns in the neighborhood of approximately 8% to 15%, with relatively moderate risk. Borrowers are screened by the service and must meet certain requirements in order to obtain loans.
The feature of peer-to-peer lending that vastly reduces risk is the structure of the loans. The risk on any individual loan is spread across a large number of lender investors. Individual lenders usually fund no more than $25 to $50 of any one loan. An individual seeking a loan of $2,000 for home improvements, for example, may have the loan funded by 40 different individual lenders, each providing $50 toward the loan total.
The lending service evaluates borrowers and the purpose of the loan to determine credit risk and the interest rate to be charged for a loan. Individual lender investors can select their level of risk to determine which kinds of loans their money will be used to fund. Even if a single borrower defaults now and then, because the investment is spread across so many different loans. Still, in recent years, lender investors were able to earn an overall return of 6% to 10.8%, depending on the loan grade of risk. Loan default rate on Prosper.com vary between 2.6% and more than 15.9%, again depending on the loan grade of risk.
One of the advantages of putting money into a peer-to-peer lending account is that an individual can open a lending account with a very low minimum deposit, as little as $25 to $50, then add money to the account monthly just as one does with a savings account.
Although this option is not government-insured, guaranteed income in the same way that a savings account is, it can be a low-risk investment that offers potential returns far above what a regular savings account offers. However, the regulatory environment around P2P lending is complicated and can differ from state to state. Due diligence before investing—and careful examination of how payment to you as a lender is organized—is especially necessary here.
The Bottom Line
There are definitely alternatives to the traditional passbook savings account that allow you to earn higher interest rates on your money. They may not offer the liquidity of a savings account and they do come with requirements ranging from minimum balances and monthly limits on transactions to lack of federal insurance. But, depending on your financial situation, they could prove attractive.