Do you get a little pissed when the high yield savings account rates go down the minute you sign up? I do.
It’s no secret that institutions are dropping interest rates like fighter jets in World War II, but for what reason? Sure, everyone talks about the record low federal reserve funds rates but despite the rate staying steady for many months now, the interest rate on our accounts still keeps going down.
Being the curious David that I am, I went around and asked a few people within the industry and what they told me is so simple and made so much sense.
The high yield savings account rates are decreasing because they don’t need your money anymore. Here’s just a few reasons why.
- FDIC Coverage – The government increased the insurance coverage from $100,000 to $250,000. This guarantee entices the average Joe to put more money into banks, as opposed to other investments.
- Economic Environment – The stock market is on fire and economists everywhere are claiming that we are well on our way to recovery, yet real Americans are still in a recession. In any bad economic environment, everyone usually keeps more money in safe investments like an high yield savings account.
- Lending – The reason why any institutions want your money is because they can lend it out at a higher rate and pocket the difference. Nowadays, the financial community is finally realizing that bad loans can become a problem, so lending standards have tightened and hence there’s less of a need for deposits.
How to Predict High Yield Savings Account Rates
This all make sense, but it doesn’t help one bit if we can’t tell which institution is going to offer higher yields in the future. So, I did some thinking, and here’s what I came up with.
In order to predict which high yield savings account will give the best rate going forward, all we need to do is figure out how much lending they will need.
Now, I know some of you are thinking that this is a bit over the top and too difficult, but it’s not that hard with a bit of logic. Here are a few examples.
Ally Bank
Most of this bank’s funding is for GMAC, who in turn lend to customers who want a Chrysler and General Motors vehicle. During the GM bankruptcy, rates have been dropping like a rock. Since cash for clunkers and demand picking back up a little, rates have edged up. Coincidence? Probably not.
Click Here to Sign Up for a Free Ally Bank Account
EverBank Yield Pledge Account
This bank is based in Jacksonville FL, so it is only natural that a large portion of their customer base is in Florida. Therefore, lending will be somewhat tied to the local economy of the state. During the past six months, the economy hasn’t really picked up, so the rates have been steady.
Click Here to Sign Up for a EverBank Yield Pledge Account
Etrade Financial
This used to offer very high rates, but their interest rate is one of the lowest in the industry. Want to know why? Since a year ago, they exited the mortgage industry and the institution still does not directly lend to customers. Don’t expect the rates to go up anytime soon either.
Bank of America
Want to know why your traditional bank never offers any enticing interest rates? The answer lies in the fact that they have so much deposits already. Bank of America has the largest deposit base in the whole industry. Is it a fluke that they are also the largest consumer lender? Chances are good that their rates will never be high enough to compete with the high yield savings accounts.
Click Here… Never mind. If you really want to sign up for an account with a traditional bank, the best perks are offered to those who talk to a banker. So if you want a Bank of America account, head down to the branch and let them take your money.
A Little Thinking About the High Yield Savings Account Goes a Long Way
Next time you open a high yield savings account, take a quick look at their business model and you will easily figure out which institution will give you the best rates going forward.
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Yes it is best to look at the business model and see which one will give a better rates. Wonderful article as usual thanks for the information.
It is fair to say that Fed Funds and savings account rates (also CDs, MMAs) are correlated. But not directly tied. The spread between them also gives an indication of what the market thinks about the rate.
You can still find some 1Y CD rates at 2.00%. That is a full 2% above fed funds which is quite high historically. This would lead you to believe that the market thinks Fed Funds are too low. And there is quite a spread between 5-year CDs and 1-year CDs. Banks do believe rates will go up at some point and are paying somewhat of a premium for them.
In 2006-2007 (I think that was the time frame), when Fed funds was at 5.25%, most banks were offering 1-year rates at about the same level. Certainly you found some deals, but the spread was much smaller than it is now. And in most cases, 5-year rates were actually lower, thus giving an inverted yield curve, an indication of rates more than likely going down. And of course we know what happened.
Great insight. I think that trying to read between the lines of what banks think about the rates is much more accurate than listening to those “experts” on CNBC.
I would also add that part of the reason why the spread is so high currently is because no one is ever going to deposit money if the spread is close to historic norms. I mean, who in their right mind would bother with putting money in the savings account if the rate is at 0%? At that rate, you can put it into the S&P 500 and still have a 4%+ cushion because you will get dividends.
If you look at the rate brick and mortar banks offer for savings it’s very close to what the Fed Funds rate is.
Still, I think online high yield savings accounts are worth it. Like mentioned above, even small differences in the interest rate add up over time and I think online accounts are a great way to save.
Thanks, everyone raves about ING, you have a favorite?
@Moneyning Maybe to the littlest degree, how difficult is it to switch?
Actually, they are incredibly easy. Pick any one (except Discover which takes much longer) and the account opening process usually takes five minutes. Then, you just wait for the funds to be transferred over.
Note that most banks hold your deposit a few days to verify that you aren’t trying to commit fraud by saying you have X amount in the source account when you don’t. The good part is that as soon as your account is open, your deposit will start earning interest even though your deposit is on hold.
This is why I have not converted yet. Seems a little shaky and the rates are the same as money market accounts right now. If they go back up, then I will make the switch.
There are online money market rates that are comparable (and in EverBank’s case, even higher). However, why don’t you look at them if they are actually higher? I mean, if your money market rate is 1.5% and Ally is giving you 1.80%, 0.30% still adds up through time.
Bank rates are tied directly to the Fed funds rate. The Fed sets a target rate to help control the flow of money n the economy. The rate has been close to zero recently so account rates are low as well. The theory is that when rates are low there is more incentive for firms and people to borrow (cheap to borrow) and spend (when rates are low it’s not wort it to save). With more spending the economy grows (or is supposed to). The Fed chief recently said that rates won’t go up until the economy is well on it’s way to recovery so I don’t think we should expect rates to go up anytime soon. I think rates have been gradually lowering because banks were waiting to see if Fed rates went back up but I think we’ll see them drop further in the near future.
It is a common misconception to directly associate the savings account interest rates (which concerns us) with the federal funds rate (which is more of an interesting fact for most of us). The federal funds target rate is what the federal reserve set. From that, and through open market operations, they arrive at the federal reserve effective rate. This rate is used by banks to lend EACH OTHER money, generally to keep up with capital requirements by the government.
There’s also a discount window, where banks can borrow funds from the federal reserve using the discount rate, which the federal reserve sets. These funds are meant to be short term loans, and are used to tied institutions over very short periods of time. These funds too, are not used for lending.
The reason why lowering the fed funds rate spurs economic lending and thus activity is because the lower theses short term rates, the less the cost for banks to borrow from different banks and through the fed when they are in need of capital. This, in turn means they can lend out more of the money they already have (ie, take on more risk). When there’s more supply in the market, the rate usually goes down to reflect this.
So, yes, which the rate we care about (mortgage rates, savings interest rates etc) are tied somewhat to the fed rate, it only indirectly effects it, which is surprising for many people.