Key takeaways
- Online banks are competing against established banking institutions, which may be one reason why they’re offering interest rates over 4%.
- It’s important to compare more than just the APY before switching banks.
- Opening an online bank account is relatively easy, and you don’t necessarily have to close your brick-and-mortar bank account.
Americans have gotten more comfortable with banking online. Among the reasons for their growing popularity: online-only banks often have higher annual percentage yields and lower fees than brick-and-mortar banks.
There are a few trade-offs to be aware of, though, especially if you prefer the face-to-face interaction traditional banks offer.
If you want to know why online-only banks can offer higher interest rates than their brick-and-mortar peers, you’ve come to the right place. We’ll explain some key differences between online vs. traditional banks you should know. We’ll also cover some factors beyond APY to consider if you’re thinking about switching banks.
Why online only banks can offer higher interest rates
The national average APY is 0.46% for savings accounts and 0.66% for money market accounts as of late February, according to the Federal Deposit Insurance Corp.
Online banks frequently offer APYs that are 10 times higher than these national averages -- the best online-only high-yield savings accounts pay APYs above 4%. Recent research also shows that online banks increase APYs by a greater amount when the Fed hikes rates compared to their brick-and-mortar peers.
There are a couple of factors that may help explain why online banks offer higher interest rates:
Less overhead
Perhaps an obvious reason online banks can offer higher interest rates is that they have lower overhead than brick-and-mortar banks. They don’t have to pay for the costs of operating and staffing bank branches.
Competition
We tend to stick with our banks for a long time, in part because it’s perceived as a headache to switch.
So traditional banks may have less incentive to up their interest rates. They know that once they have your money, you’ll probably keep it there for a long time.
By contrast, online banks have to compete for your money. Even though the number of customers who use digital banking is growing, online banks only accounted for 5% of deposits held in financial institutions nationwide as of March 2023. Because it’s easy to compare APYs using a smartphone or computer, banks need to compete more for customers who shop for financial products online.
Is it worth switching banks for an interest rate?
Most savings accounts have variable interest rates, which means they fluctuate based on market conditions. If you read the fine print in the terms and conditions for many bank accounts, you’ll see that they reserve the right to change your APY at any time with no notice.
If you’re already earning a competitive interest rate, it may not be worth switching institutions. For example, if your savings account pays 4.70% and another institution offers 4.90%, the extra interest you earn may not make a huge difference, especially since APYs can change. But if you’re only earning the national average rate of 0.46%, it’s worth exploring the alternatives.
Here’s how $10,000 of savings would grow at a 0.50% APY vs. a 5% APY, assuming that interest compounds daily and the variable rate doesn’t change.
| 0.5% APY | 5% APY | |
| Balance after 1 year | $10,050 | $10,512 |
| Balance after 3 years | $10,151 | $11,618 |
| Balance after 5 years | $10,253 | $12,840 |
| Balance after 10 years | $10,512 | $16,486 |
As you can see, locking in a higher APY pays off over long periods of time thanks to the magic of compound interest. Essentially, the interest your money earns generates even more interest, allowing your savings account balance to balloon over time.
Should you switch from a traditional bank to an online bank?
APY isn’t the only factor that matters when you’re choosing where to bank. You also need to know whether your deposits will be federally insured, which is vital for keeping your money safe. Here are a few ways to be sure a bank deserves to hold your money.
Is it legitimate?
It’s essential to keep your money at an institution that’s federally insured in case your bank fails. The FDIC covers an individual’s deposits at banks for up to $250,000 per account category, per institution. Funds stored at a credit union have the same coverage, but they’re insured by the National Credit Union Administration instead of the FDIC.
Some online banks are neobanks, which are fintech companies that provide mobile banking services -- but many aren’t chartered banks. Often these companies partner with FDIC-insured institutions to deposit customer funds in federally insured accounts.
But the FDIC warns that money transferred to a non-bank institution is never FDIC-insured until the funds are deposited at a federally insured institution. If you’re considering a neobank that contracts with an FDIC-insured bank, make sure you know when and how your money will be deposited in an insured account.
Pro Tip: Confirm the institution is insured
You can use the FDIC’s BankFind tool or NCUA’s Find a Credit Union database to search for your bank or credit union and confirm that it’s insured.
Fees
Before you switch banks, be sure to compare the fees. Some common banking fees include:
- Monthly maintenance fees
- Overdraft fees
- Nonsufficient fund fees
- ATM fees
Some institutions also require a minimum deposit. You may also be charged a fee if your balance dips below a certain amount.
Customer service
Consider your options for accessing customer service if you’re toying with the idea of switching banks. Find out whether there’s 24/7 customer support and whether it’s available by phone, online chat or both. And read reviews on third-party sites to see if customers are generally satisfied.
Other financial services or features
A few other questions to consider before making the switch to an online bank:
- Is there a free ATM network? Most online banks have a large network of ATMs that customers can access without paying a fee, or they reimburse customers for ATM fees.
- Can you deposit cash? One common pain point of online banking is that depositing cash can be difficult. Find out whether it’s possible to deposit cash or if you’ll need to do so via a linked account.
- Will you get a welcome bonus? You may be able to earn a bank bonus for opening a new account. Though you can score a bonus for both savings and checking accounts, bank bonuses are more common with checking accounts.
- Does the institution offer other financial services? Many fintech companies offer other banking services, like lending and investment services, which could be convenient if you prefer to manage your finances in one place.
- Do you prefer face-to-face interaction? If you frequently visit your local physical branches, consider whether pursuing a higher APY is worth the trade-off of not having in-person contact.
Should you switch to an online bank or just add another account?
You could switch entirely to an online bank, but that may not be necessary if you’re simply looking to lock in a higher APY on your savings. One option is to open a high-yield savings account at an online bank while keeping your checking account with your existing bank. That way, you don’t have to switch over automatic bill payments and deposits.
You can usually link your checking account at a regular bank to your online savings account. Doing so may make it easier to access ATMs and deposit cash.
How to switch to an online bank account
It’s fairly easy to open an online bank account if you’re ready to make the switch. You can apply in just a few minutes using your phone or computer by taking the following steps.
1. Gather relevant info
You’ll need to provide a few pieces of information, like your name, address, date of birth and Social Security number. You may also be required to upload a copy of your driver’s license or another government-issued ID.
2. Track and transfer automated transactions
If you’re opening a new checking account, make a list of any automatic bill payments you’ve set up and switch over the accounts. Review at least a few months’ worth of bank statements to ensure your list is complete. If you forget to transfer a bill, you could get hit with fees or wind up having a service suspended.
Also make sure you set up any recurring direct deposits for your new account. For example, you’ll need to provide the new account details to your employer so you can get your paycheck. Make sure you do the same for other sources of recurring income, like Social Security.
3. Monitor your old account
You may want to leave some money in your old checking account for a month or two. If you have outstanding checks or debits that haven’t cleared, doing so can prevent any payments from being interrupted.
4. Close your old account
Once you’ve double-checked that you don’t have any money going into or out of your old account, you can transfer the rest of your funds and close the account. The Consumer Financial Protection Bureau suggests getting written confirmation from your old bank that the account is closed.
After you’ve completed those steps, you can proceed with all your regular banking activities in your new account -- and, hopefully, enjoy a higher APY.
