Have you ever looked at a few banks and wondered why the rates, or Annual Percentage Yield (APY), are different from place to place?
According to rate-tracking site BankRate.com, APYs can be as low as 0.01% to well over 2.00%. That’s a pretty big range.
What’s the deal? In short, APY can be a kind of promotional game in the banking industry—but it’s one that actually benefits you if you know what you’re looking for and read the fine print.
What is APY?
First, what is APY? APY is an acronym for Annual Percentage Yield and it represents the amount of interest you’ll earn after a year of compounding interest. For example, if you have $10,000 in savings, you’ll earn $2 with 0.02% APY and at 2.00%, you’ll earn $200.
However, you always want to read the fine print closely—many of the places offering the highest APY have other catches, like a minimum balance requirement or a fee if you don’t hold the minimum balance.
At Varo, we offer a Savings Account with 0.50% APY* with no catches—that means no fees or minimum balance requirements to open the Savings Account. Compare that to the national average of 0.06%.**
However, people often wonder why there is such a range of available rates. Here’s why.
Reason #1: Banks may use APY to promote deposits so they can make loans.
In the world of banking, your cash—whether it’s in your bank account or savings account—is a deposit. And banking institutions rely on these deposits to support other parts of the business, such as making loans. To incentivize you to make deposits, a banking company might raise its rates.
“Deposits are the fuel that drives the lending engine,” said Greg McBride, Chief Financial Analyst for Bankrate.com. “When banks have higher loan demand, they have higher deposit needs to feed the machine.”
Reason #2: Every banking institution has a different cost structure.
Online-only banks may have lower expenses than brick-and-mortar banks, as they don’t have to pay as much for bank branches and associated personnel and upkeep costs.
“The lower cost base gives them more latitude,” said McBride, which is one reason you may see online- and app-based savings accounts offering higher interest rates and charging fewer fees.
Online banks and high-yield savings accounts tend to offer the highest rates, and when one financial institution raises rates, the rest may follow.
“Among the top-yielding accounts, it’s very competitive,” said McBride. “They continue to raise payouts and leapfrog each other.”
Even with their branches, credit unions also have more latitude because they’re nonprofits, said McBride. “But they may decide to invest in more products or services rather than [higher] returns.”
Credit unions that do offer higher rates may do so with high-yield checking accounts, which require members to meet certain criteria (such as regularly using the debit card or logging into their account) to receive the higher rate.
So why don’t the largest banks have competitive rates?
If customers can get a higher rate by switching accounts, why don’t big banks offer the same or higher interest rates than online banks and credit unions?
In short, it’s because they don’t need your money. They tend to have less need for consumers’ deposits as they could have large deposits from businesses or investors. For example, JPMorgan had $1.3 trillion in deposits alone in 2017.
“The big banks that have the most market share also have the most pricing power,” says McBride. “They don’t need to pay higher rates on deposits because their vast branch [networks] and ATM networks act as a catcher mitt.”
In other words, collecting fees on other services could offset the need to attract consumer cash deposits to use for a lending business.
By offering a wide range of products, big banks also tend to attract customers who want to do all their banking with one company rather than shopping around. And, once they’re customers, people may be hesitant to change banks.
And to be sure, new companies, like Varo, are challenging these big institutions—offering a suite of banking services with no fees and high rates.
So while traditional banks might hope you’ll stick around because it’s time-consuming to move on, it really does pay off for people to do some comparison shopping
Finding a higher rate for your money
Does it make sense to switch from an account that offers 0.02% interest to 0.03%? Probably not. But the difference between big banks’ rates and online and mobile banking rates is often much larger.
“What really counts is the buying power of the money,” says McBride. “If you’re earning a rate of return that isn’t keeping pace with inflation, you’re losing buying power.” For perspective, the Bureau of Labor Statistics reports that the inflation rate was around 2.10% for the first half of 2018.
But there’s more to consider than just interest rates when comparing bank and savings accounts. You’ll also want to consider all the fees that could be also included. Varo is proud to offer no-fee Bank and Savings Accounts.
And convenience is a factor to consider as well—the ease with which you can get money in and out of your savings account is important to consider.
However, if you find a savings account that offers a higher rate, no fees and is easy to use, it could be worth switching.
“If you’re sitting back and waiting for the big bank to bestow higher rates you’ll be sorely disappointed,” said McBride.
Louis DeNicola is a freelance personal finance writer and credit enthusiast. You can find him on Twitter @is_lou.