What are High-Interest Savings Accounts & How Do They Work?

When you start comparing your options for a high-yield savings account, you’ll notice that different types of accounts come with different interest rates and rules. Learn how and why these accounts vary in order to choose the right ones for your savings needs.

How banks set interest rates                                            

Rates for high-yield savings accounts are set based not only the current economic state (better times breed better interest rates), but also on the nature of the account in question. Here’s how it works:

• Banks use their customers’ deposits to lend money to other customers.
• The more the bank has at its disposal, the more it has to lend; thus, the more new customers it can attract.
• Therefore, banks reward customers who intend to keep their money in the bank the longest (giving it more to lend) with higher interest rates.
• All the time, these funds are FDIC-insured, meaning customers can’t lose their money.

Let’s look at the three main types of high-interest savings accounts to see what this means for you.

• When a person opens a certificate of deposit (CD), he commits to leaving his money untouched for the duration of the CD term. The bank is then guaranteed that these funds will be there for future lending purposes, and the bank rewards him with a higher interest rate.
• A money market account allows some access to the funds, but it tends to be limited. Money markets may also have minimum balance requirements. Because of these moderate restrictions, the interest rates on these accounts tend to be competitive but not quite as high as on CDs.
• In a basic savings account, the account holder can withdraw all of his funds, penalty-free, at any time. So, as the bank is unable to rely on this money, it pays a little less in interest.

What this means for you as the account holder

The good thing about high-interest savings accounts is that, while all of the above is going on, you still have the freedom to choose the types of accounts and the number of accounts you wish in order to meet your savings needs. If you need immediate access to your savings, then a savings account or money market account, which allows limited access, is better for you than a CD, which allows no access. If you’re looking for maximum, long-term savings, a CD is probably the better choice.

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Or, you can open several different types of accounts to meet your various needs. In the end, you’ll still be availing yourself of a safe way to save and grow your money.