Though rates have dropped dramatically, some online banks are offering as much as 3.5% for savings accounts. It pays to look around
Peter Profesda admits he's a rate-chaser. The teacher of computer classes at a two-year college in New York spends a few hours a week checking bank Web sites and banking-related blogs to find the highest yield and other promotions. He's changed banks numerous times in the last few years, or has at least opened additional accounts, just to take advantage of promotions. Once a customer of ING Direct, a Wilmington (Del.) subsidiary of Netherlands-based ING Groep (ING), he switched to FNBO Direct last year after being lured by an offer of a 6.01% annual percentage yield (APY). Shortly after he opened his FNBO account, the bank cut its rate to 5.05%, and then to 4.30% and to 3.25%, where it stands currently. But Profesda was able to enjoy the promotional rate for his first three months at FNBO Direct.
More recently, though, online banks have had to lay low on promotions due to how dramatically interest rates have dropped over the past nine months, says Jim Bruene, editor of the Online Banking Report. "Lately I haven't seen too many promotions [for higher rates]," says Profesda, as he surfed the Web at ING Direct Cafe in midtown Manhattan on a warm June afternoon. (ING Direct Cafe offers Internet access and is a gathering place for consumers to buy coffee, tea, and snacks—the cafe does not have banking services.)
While online customers tend to chase higher yields, it's harder to get them to move their money when rates are around 3%, says Bruene. "There's some psychology at play," he says. "People have in their minds putting money away at 5%. Once they go into the [3% range], there's less motivation psychologically."
Stiffer Competition, Higher Yields
One bank still on the prowl for market share is HSBC Direct, which on June 2 launched a promotion that raised its rate for new and existing customers' savings accounts from 3.05%, to 3.50% through Aug. 15. The bank plans to review how interest rates are moving in the market in the interim, says Kevin Martin, the head of HSBC Direct U.S.
While the Federal Reserve has slashed its key interest rate since September, 2007, rates for high-yield savings accounts have come down only a fraction of the drop in the federal funds rate, says Greg McBride, senior financial analyst at the banking Web site Bankrate.com (RATE). "A year ago, [savings] rates were about 5.0% and they fell to about 3.5% despite the Fed funds [rate] going from 5.25%, to 2.0%," he says. That's mostly due to the stiff competition for customers and conditions in the credit markets that have made it less costly for online banks to pay higher yields on deposits than to try to attract funds in other ways, he adds.
Unlike short-term Treasury bonds, online bank rates aren't linked to the Fed funds rate or the London Interbank Overnight Rate, or Libor. Instead, they track the market of all banks offering online banking products. "It really is a micro market driven by the competition," says HSBC Direct's Martin.
Banks have the freedom to lower and raise rates on little or no notice to customers. To lure new customers, HSBC Direct is locking its new rate of 3.50% for 75 days. But this is "not a big leap in an environment when the Fed is expected to be on the sidelines [with respect to lowering rates any further]," says McBride at Bankrate.com.
Pursuing the Highest Return
One reason online banks can afford to offer rates that are six to seven times higher than those at typical brick-and-mortar banks is that online banks tend to have lower costs since they don't have to manage branches. Plus, online banks need to offer extra incentives to lure customers away from their traditional bank. "In the consumer world, you have to do something to make people aware of you. Part of it is having high rates," says Bruene.
He estimates that seven to eight million U.S. households, or roughly 6% to 7% of the country, maintain an account at an online-only bank. Consumers who have high-yielding accounts are more likely to pursue the highest return and move their money elsewhere. Since deposits of $100,000 and less at all consumer banks are equally protected by FDIC insurance, there's no additional risk in moving your money to a bank offering the highest return, says McBride.
Savings Accounts with the Highest Rates ($1 minimum to open account)
Annual Percentage Yield
Source: Bankrate.com. Rates are as of June 2. * APY is available through Aug. 15, 2008
Not all rate chasers are as obsessed as Profesda. George Cominskie, a photo agent in New York, says he spends at most two to three hours a month shopping for the best rates on CDs and money market accounts for his excess cash, while using Wachovia (WB) as a home base for his savings account. He likes to stow the money he doesn't need day-to-day at assorted locations, moving it around whenever a locked-in rate expires to the next high-yield deal he has found. "When my E*Trade CD comes up and all of sudden I have $25,000 [to invest], by putting it into my money market [account] at Wachovia, I'm guaranteeing 3.5% for four months, and it's liquid that whole time," he says.
"Pretty Close to a Free Lunch"
Cominskie says friends and neighbors will stop him on the street to ask him for advice about where to stash cash. He likes General Motors Acceptance, which now offers a CD at 3.65% if you don't withdraw money for 12 months and at 3.55% for nine months. The minimum balance required is $500.
Cominskie and Profesda come close to fitting McBride's description of online banking afficionadoes who "tend to be evangelists." As they've already learned, by doing online banking, "the additional return without additional risk is pretty close to a free lunch," McBride says.
Indeed, it's easy to find a rate at an online bank that beats the paltry 0.5% or less for savings accounts at traditional brick-and-mortar banks, which usually don't offer higher rates because it would squeeze their margins and hurt profitability. "There's a tendency for consumers to set it and forget it in matters of personal finance, and that can cost you a lot of money in the long run," says McBride. "At the very least [you should be] looking for a return that can preserve your buying power."