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How does a high-yield savings account work?

Adopting good saving habits can improve your financial health. Imagine not having to reach for a credit card or borrow money when the unexpected happens because you have the money in the bank.

Saving isn't just good from an emergency standpoint. Putting money in the bank can also help you grow wealth, thanks to the effects of interest.

With savings accounts, you earn interest on top of the interest you already made. When that interest rate is high, you can watch your money grow quickly.

A high-yield savings account is one option for those hoping to build their savings faster than you can say, "dolla dolla bills, y'all!". This guide breaks down what they are and how they work to help you decide if you should open one.

What is a high-yield savings account anyway?

A traditional savings account pays interest, but the annual percentage yield (APY) on these accounts is often less than 1%. Your money will grow but at a slow pace that's not exactly inspiring.

A high-yield savings account is an option for people who want to earn more interest. Rates vary from bank to bank, but they consistently pay more than traditional savings accounts.

Many of these accounts are available through online financial institutions. Hint: This isn't just a coincidence. Online banks typically have lower operating costs, allowing them to offer more attractive interest rates than their brick-and-mortar competitors.

Things you need to know about high-yield savings accounts

So far, high-yield savings accounts sound pretty good, right? Everyone wants to earn as much interest as possible. Still, there are some important facts about high-yield savings that you need to know before opening an account.

You'll earn interest every day

Every day you have money in a high-yield savings account, it's growing. Many financial institutions calculate interest daily.

To do so, they divide the Annual Percentage Yield (APY) by 365 and then multiply your balance by that amount at the end of every day. Most accounts pay the interest out monthly.

High-yield savings accounts that offer compound interest are even sweeter deals. With compound interest, you earn interest on what you've already earned. This means by the end of the year, you've made a little extra money.

Here's an example:

  • You maintain a balance of $1,000 in your high-yield savings account.

  • The account pays 1% APY.

  • With simple interest, you'd have $1,010 at the end of the year.

  • With compound interest, you'd have $1,010.05.

  • After 10 years, the simple interest method gives you $1,100.

  • After 10 years, the compound interest method gives you $1,105.17.

You'll need to maintain a minimum balance

To open a high-yield savings account, you may have to deposit a minimum amount initially. Each bank has its own opening balance requirements.

You'll also likely need to maintain a minimum balance to get the promised high-yield APY. If your balance drops below that amount, your interest rate may be lower. Again, the magic number you need to have in your account varies, so put on those cheater glasses and read that fine print.

You might be charged fees

Some high-yield savings accounts charge monthly maintenance fees. This is a way for financial institutions to cover costs associated with your account.

Your withdrawal ability may be limited

Before the COVID-19 pandemic, the federal government required banks to limit withdrawals and outgoing transfers from savings accounts. Called Regulation D, this rule limited you to six transactions per statement cycle. If you went over, your bank charged a fee.

The Federal Reserve has stated that it doesn't intend to put the regulation back into effect. However, banks have the right to limit your withdrawals and outgoing transfers. They may still charge you a fee if you exceed a set number of transactions.

What are some examples of a high-yield savings account?

Finding a high-yield savings account can be tricky because financial institutions may not refer to them specifically as high yield.

Some well-known high-yield savings accounts include:

  • UFB Direct High Yield Savings

  • Marcus by Goldman Sachs

Varo's Savings Account

The Varo Savings Account pays one of the highest APY rates in the country¹. You get an introductory 3.00% APY to help grow your money fast.

By receiving direct deposits of $1,000 or more in one month and ending that month with a positive balance in your Varo Bank Account and Savings Account, you can qualify for an even higher 5% APY rate for the following 30 days. There's no monthly fees and no minimum balance required, so you keep more of your hard-earned money. Pretty awesome, right?

How do I open a high-yield savings account?

Generally, opening a high-yield savings account is easy because of the convenience of online banking. Here's what you need to do step-by-step:

1. Shop around

As you can see, you can choose from many high-yield savings accounts. Each one has its own unique features and benefits as well as some drawbacks. That's why it's important that you do your research.

Check out three or more high-yield savings accounts before you choose one. If anything is unclear about the Terms and Conditions, contact the institution's customer service department.

2. Open your account

Once you've picked the account that best suits your needs, the next step is to go through the opening process. Normally, you'll need to supply your:

  • Legal name

  • Email address

  • Cell phone number

The financial institution will ask you to select a password and agree to receive electronic communications. You may also get a text with a code to enter on the site to verify your account.

3. Provide the necessary information

After your account is set up, the financial institution must verify your identity. To do so, they'll ask for additional information, which may include your:

  • Social Security number

  • Driver's license or state-issued ID number

  • Date of birth

  • Current physical street address

Because you're entering personal information, do this step on a private Wi-Fi network rather than in a public place.

4. Make your first deposit

Once the financial institution verifies your identity, you're ready to make your opening deposit. In most cases, you can do this by transferring money from an existing checking or savings account.

You'll need your current bank's nine-digit routing number and your account number to initiate the transfer. In addition, the financial institution may ask for the address of your current bank.

5. Set up regular deposits if you wish

Many online high-yield savings accounts give you the ability to schedule regular transfers. You can elect to deposit money weekly, every other week, bi-monthly, monthly, or on a schedule that suits you.

Automating deposits can simplify saving. Just ensure you have sufficient funds in the account that you're drawing from to avoid overdraft fees with your current bank.

How do I choose a high-yield savings account?

There is no single best high-yield savings account for everyone. To decide which account is the right fit for you, consider:

  • APY:

    How much interest will you earn? When does interest get credited? Does interest compound?

  • Fees:

    What fees will you have to pay? Can you avoid fees by maintaining a minimum balance?

  • Balance requirements:

    How much do you need to open the account? How much do you have to keep on deposit to earn the best rate of interest?

  • Website or app:

    How easy is it to use the website or mobile app? Can you set up automatic deposits?

  • Transaction limitations:

    Does the bank limit your withdrawals and outgoing transfers? If so, what's the fee if you go over?

  • Protections:

    Is the financial institution insured through the Federal Deposit Insurance Corporation (FDIC)? FDIC insurance protects you in the event of a bank failure. It provides up to $250,000 of coverage per depositor, per bank, per ownership category.

  • Reputation:

    What do customers say about the bank in reviews?

What are the benefits of a high-yield savings account?

There are two key benefits of a high-yield savings account. Both relate to interest.

First, a high-yield savings account protects you from financial loss. Your balance isn't tied to the performance of the markets. This differs from an investment account, which carries risk.

The second key benefit is the APY compared to a traditional savings account. A high-yield savings will pay you more over time.

What are the drawbacks of a high-yield savings account?

While high-yield savings accounts do offer higher interest rates, they're usually not the highest-paying options. For long-term savings, such as for retirement or higher education, another type of account with a higher rate may be a better solution.

Another downside is the potential for difficulty accessing your money. Online accounts usually eliminate your ability to walk into a bank and withdraw cash.

What are some other savings options I should consider?

Before opting for a high-yield savings account, compare the benefits and drawbacks to the other options discussed below.

Certificates of deposit

Also known as CDs, certificates of deposit may pay higher rates of interest than high-yield accounts. To get this higher APY, you promise to leave your money on deposit for a set period of time. This is called the CD's term.

Terms vary from a few months to several years. Generally, the longer the term, the higher the interest rate will be.

If you need the money from a CD early, the financial institution will charge you a penalty. In some cases, the bank will waive this if you're using the funds to open another type of account with the same institution.

Money market accounts

Money market accounts or MMAs are savings accounts that often pay more than high-yield savings. You'll usually need a larger opening deposit and be subject to higher minimum balance requirements.

Interest rates on MMAs vary based on the performance of the stock market. During economic booms, you stand to earn high rates. On the flip side, downturns can mean your savings grow much more slowly.

With MMAs, only your interest rate is unpredictable. You won't lose any money you deposit during tough market conditions. Like high-yield savings accounts, money markets are usually FDIC-insured and may have transaction limits.

Stocks

The stock market could earn you a much higher return than the interest paid on high-yield savings, CDs, and MMAs. Of course, you also stand to lose all of your initial investment money.

Although it's now easy to manage brokerage accounts on your own, knowledge of the market is key to making smart investments.

If you want to invest in stocks, enlist the help of a licensed financial advisor who knows their stuff and isn't afraid to share.

Will they run a credit check before opening my account?

Generally, financial institutions do run a credit check before opening a high-yield savings account. These checks are usually soft, meaning they don't affect your credit score.

If you have a low credit score, don't panic. You could still qualify for a high-yield savings account.

Compared to loans and credit cards, savings accounts carry little risk to financial institutions. As a result, they usually have more lenient standards for determining eligibility.

One thing that could prevent you from opening a high-yield savings account is a previous bank charge-off. A charge-off occurs when an account remains overdrawn for so long that the bank writes it off.

Financial institutions use a service called ChexSystems to identify individuals with previous charge-offs. If a bank finds you in the system, they may refuse to open the account. Or, they might require you to pay the charge-off first.

How often can banks change interest rates?

How often a bank can change interest rates on your high-yield savings account depends on your account's terms. Your account disclosures will provide information about when variable interest rates may change.

Generally, banks have the option to change variable interest rates whenever they want. They normally do this in response to changes in the federal funds rate or FFR. This figure is the amount that banks pay to borrow money from the Federal Reserve and is impacted by inflation and market performance.

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