A reader asked me if there was a difference between a FDIC-insured “savings” account and an FDIC-insured “money market” account. A bit of online searching and the venerable Wikipedia yielded the answer, plus some interesting facts about savings accounts.

First of all, why do savings account usually have higher interest rates than checking accounts? I think most of us know that banks make money by using our cash deposits and lending it out to others via mortgages, personal loans, or credit cards. However, we also expect that if we do want to withdraw our money, it will be there. To achieve this, each country sets its own reserve requirements, essentially how much cash the bank must physically keep in a vault somewhere to meet expected withdrawal demands.

As of 2006, the required reserve ratio in the United States was 10% on transaction deposits (checking accounts), and zero on time deposits (savings accounts). Due to fractional-reserve banking, having no reserve requirement allows the banks to lend out much more than their actual deposits.

Added: A quick explanation… At a reserve ratio of 10%, let’s say I put in $100. That means the bank can lend out $90. If whoever borrows that $90 put it in a bank, then the new bank can lend out 90% of that, or $81. This could repeat forever, leading to banks lending out 100+90+81+… = $1,000 for each $100 in deposits. This is just for a checking account. For a savings account, with zero required reserves, a bank could theoretically lend out an infinite amount of money (100+100+100+…). Aren’t you glad your money is insured now? 😉

The main difference between checking and savings accounts are their transaction limitations, as outlined by Regulation D. You can only transfer funds out of your savings account up to six times per month by any pre-authorized method like online or telephone transfers, even to a checking account within the same bank. A max of three of these can be via check or debit card. You can still make unlimited withdrawals in person via a teller or ATM.

This is why it can be difficult to use your online savings account (at over 5% interest) as your sole account for paying bills and such instead of your checking account (often at 0%). Bank often charge fees for breaking this rule, and must close accounts where this transaction limit is repeatedly exceeded.

Back to the initial question – Is there a difference between a FDIC-insured “savings” account and an FDIC-insured “money market” account? From what I could find, no. They are both time deposit accounts, just with different naming conventions. Traditionally, money market accounts have a higher minimum balance requirement, and are more likely to offer checkwriting or a debit card (subject to the limits above). These both remain different from money market mutual funds, which are usually not FDIC-insured and are instead a collection of short-term debt instruments.

As online savings accounts get more and more popular, I get the feeling that they are becoming a mature product, almost a commodity. Sure, there will still be the occasional promotions, but for the most part all of the banks now are hovering around the same interest rate (currently ~5% APY). I believe that the banks simply don’t have the ability to go that much higher and remain profitable.

Exhibit A: E-Loan Savings, which burst on the scene with a 5.5% APY rate, is now back down to 5.25% after only a few months. GMAC Bank is down to 5% APY. Both are tightly connected with streamlined internet mortgage lenders. If they can’t go higher, who can?

Exhibit B: HSBC Direct is currently offering a nice 6% APY rate on new money, but it’s temporary and will revert back to 5.05% in May.

Once every account starts paying around the same rate, they’ll will have to start competing more on customer service and convenience. People want easy online transfers between their accounts, ATM access, and a reliable and user-friendly website. Most people also value the ability to stay with their current bank.

Exhibit C: I am increasingly using my Washington Mutual 5% APY savings account (my review) because I can deposit checks and withdraw cash directly to and from the account from a local ATM, and also initiate external online transfers. If I need to write a check or make a bill payment, I just move over some money instantly to their free checking account (with 1 free overdraft as a backup). In the meantime, all but a few hundred dollars are always earning 5%.

I expect other banks with a large physical presence to follow suit, but notice that they will be only targeting internet-savvy folks who are aware of all the options! Checking accounts paying zero interest are their bread and butter, and they don’t want to make it easy on everyone to switch. WaMu’s account is only available online. (Even for their own employees! I asked.) Citibank has their e-Savings Account paying 4.75% APY, which also must be opened online. Bank of America recently rolled out an online-only 5-month CD paying 4.50% APY ($5,000 min).

HSBC Direct is offering a promotional 6.00% APY on new money only between January 29, 2007 and April 30, 2007. This for both new and existing accounts. They are pretty restrictive on the meaning of “new” money, so you can’t just take money out and put it back in and have it earn the promo rate.

Starting Balance means the available balance in your account as of the close of business on January 26, 2007. New Money means funds not previously held by any member of the HSBC Group deposited during the New Money Period less any withdrawals, and it excludes your Starting Balance as calculated below.

If you don’t use HSBC, check out my Ultimate Interest Rate Chaser Calculator to help decide if it’s worth the hassle to move money over. Currently most other similar online banks are earning about 5.00-5.25% APY. You’re really looking at a maximum of 3 months of an extra 1% APY, after which most likely the rate will drop back down. This equates to roughly $20-$25 extra for each $10,000 you move in (the lower estimate takes into account the likely lost interest during transfer).

Added: Also see my HSBC Direct Review

Pentagon Federal Credit Union is now offering a generous 6.25% APY rate on it’s 3, 4, 5, and 7-year CDs (they call it a Money Market Certificate). These rates probably won’t last, so if this looks good to you you may want to jump in now.

These certificates may be a good alternative to online savings accounts for your emergency funds or other accounts with medium-length horizons. Penfed only has a $1,000 minimum on each certificate, and has relatively lenient penalties on early withdrawals. I wouldn’t use these for retirement savings if you’re young, though.

Since this is a credit union, you must meet their eligibility requirements to join. Basically all members of the military and their immediate families are welcome, as well as many other military-related groups. Otherwise, the easiest way to join is through the National Military Family Associaton (NMFA). Membership costs $20/yr, and you don’t need to renew in order to remain a PenFed member. There are some good benefits to being part of NMFA, such as scholarships, GEICO discounts, and helping support military families.

I’ve been a member for about 3 years now, and have been very satisfied with their customer service. They have other good financial products as well, including competitive mortgage loan products.

» E-Loan Savings lowered its rate from 5.50% APY to 5.38% APY. Commenters to my Eloan Savings review added that they had some transfer glitches as well.

» iGObanking is yet another online no-minimums savings account, offering 5.30% APY. I know little else.

» Capital One 360 recently raised its rate from 4.40% to 4.50% APY. $25 opening promotion.

See my online savings account comparison for a summary of the banking options out there.

Capital One 360 is trying to stir things up again by rolling out a new high-yield 360 Checking account. Paradoxically, there will be no checks. Initially available only to “active” users of their 360 savings account ($25 signup promotion), it is not available to everyone. It offers the following features:

• 1.75% APYif your balances is under $50,000, 3.20% APY for $50-100k, 3.40% APY for $100k+
• No minimums or monthly fees
• Free ATM access at 32,000 locations nationwide
• Free BillPay and Debit Card
• No checkbooks, but you can send paper checks online.

My initial feature review:

Interest Rates – The rates are above average, but not the best. The fact that it has no minimum balance does make it unique. Otherwise, if you can satisfy some minimum balance or direct deposit requirements you can get a higher rate at various other banks including Everbank. It’s interesting to note that ING has added a tiered system now. I would remember to be careful not to exceed FDIC insurance limits.

No ATM rebates? – It turns out those “32,000 locations nationwide” are the AllPoint Network. These ATMs are often in random restaurants, so you have to go during business hours. I was hoping for something special, like the ATM fee rebates that Everbank and others provide.

Must Mail In Checks – This is my main annoyance with all online checking accounts. You can’t make deposits via ATMs, so you have to snail mail them in. Besides having to pay extra for postage, it only takes one lost check to cause a huge headache.

What Do You Mean, No Checks? – This is supposedly the most innovative thing about this account. They don’t give you checks, and you can’t even buy third-party checks with your account and routing number. You can request paper checks to be sent to specific people online, or you can send them an “electric” check with their account and routing number.

Conclusion
From the features list and what I’ve read about Capital One 360’s customer service history, I think this is a decent product. Much like their savings account, it does not have all the best features, but due to it’s relative simplicity it will work for a lot of people. If you can live with mailing in all your check deposits and live near some AllPoint ATMs, it could probably work as your main checking account. Otherwise, it may just be nice addition to your their savings account due to the lack of fees (if you use it).

Right now, I still think the best options are for people who live in a Citibank or Washington Mutual area to get a checking + 5% APY savings combo with them. You get checks, ATM deposits, high interest, and instant inter-account transfers to maximize your savings balances.

Another no-fees no-minimums online savings account has arrived. This time it’s E-Trade Bank with the Max-Rate Savings Account. After looking around, here are what I see as the pros and cons of this account as compared to other online banks.

Pros

• No minimum balance, $1 to open, no account fees
• Competitive, but not exceptional (updated) 3.30% APY interest rate.
• E-Trade Bank has a great online funds transfer system. It is CashEdge-based so you can basically link almost any external bank account (also seen at HSBC, Bank of America). But what sets it apart is its transfer speed, allowing round-trip funds transfers with zero days of lost interest. Transfers both in an out are free.
• If you use E-Trade as your broker, can transfer between E-Trade accounts instantly. It appears that you can’t use this as your sweep account though.
• I have opened a few E-Trade bank accounts in the past (for bonuses), and was not hit with a hard credit pull.

Cons

• Competitive, but not exceptional interest rate. You may already be getting a similar rate, or be able to do better elsewhere, especially if you have higher balances.
• I have had bad experiences with E-Trade brokerage, including hour-long hold times and slow service. I’m not sure if the bank has a separate customer service department.

First Impression
If you already use E-Trade, opening a Max Rate savings account is probably a no-brainer due to the lack of fees. For others that move money around a lot, it may be also be useful to open one these accounts to take advantage of those fast interbank transfers.