Contributing Writer at Tally
November 5, 2021
As you start out on your financial journey, one of the terms you’re likely to encounter is "interest-bearing." You may be familiar with interest when it comes to things like student loans or the compounding interest associated with credit cards. But did you know that interest can also be a good thing?
In this article, you’ll learn everything you need to know about interest-bearing accounts — from what interest-bearing means to the types of accounts that are typically interest-bearing and whether it’s wise to take advantage of them.
An interest-bearing account is a financial product that pays you interest on the money you have deposited. Essentially, financial institutions are paying you to keep your money with them in something like a bank account or credit union account.
You may be familiar with interest rates when it comes to borrowing money. If you borrow money through a credit card, mortgage or loan, the lender charges interest on top of the borrowed principal amount.
Just as lenders will charge you interest to borrow money, financial institutions will pay you money to keep your funds in their accounts. Banks want your money because it allows them to grow their business. They can open new branches, market to new customers and lend out money to other customers. They’re willing to pay you interest to do so.
You may be a bit concerned when you hear that banks lend out your money to others, but worry not. Your money is still your money. Depending on the account you choose, you may have access to a debit card or an ATM. Your funds are still liquid, meaning you can convert them to cash and own/repossess them quickly.
Most banks are FDIC-Insured and credit unions are NCUA-Insured. When you open an account with one of these institutions, you’re automatically enrolled in coverage. Both of these insurances say that in the unlikely event the financial institution fails, up to $250,000 of your assets are protected per financial institution.
In summary, interest-bearing accounts pay interest on your account balance. The larger the account balance or the longer the period of time you leave your money parked in one of these accounts, the larger the interest payments.
"Interest-bearing" can be broad and cover an array of accounts. Examples include:
The interest rates on these accounts are often expressed as annual percentage yields (APYs). The APYs on these accounts can vary drastically. A typical interest-bearing checking account, for instance, offers a 0.04% APY on average. A high-interest-bearing checking account, commonly offered by online banks, offers a 0.31% APY.
Online banks often offer higher APYs than brick-and-mortar locations. That's because they don’t have to worry about overhead for things like renting or buying buildings, paying utilities and purchasing office supplies. They can offer higher interest payouts as a result. There are both high-yield checking accounts and high-yield savings accounts available. The savings accounts often have higher interest rates, but you may not have the ability to write checks or pay directly with a debit card.
Interest-bearing accounts can come with some stipulations:
Minimum deposits or minimum balance requirements
Fees like monthly maintenance fees or overdraft penalties, making it important to read the fine print to ensure the fees aren’t higher than what you'll earn in interest
Withdrawal rules and penalties — for instance, savings accounts are governed by Regulation D, which means you cannot make more than six transfers or withdrawals per account per month. Additionally, certificates of deposit specify the period of time required to keep your money in the account. If you pull the funds early, you’re subject to early withdrawal penalties.
Interest-bearing accounts are deposit accounts. You can direct deposit money into the account from your paycheck or you can transfer money in. They’re noticeably different from investment accounts. Deposit accounts are FDIC/NCUA-insured, while investment accounts aren’t.
Your money may potentially grow more in an investment account, but you could also lose your money, depending on what you invest in. Investment accounts may be subject to market fluctuations, making them significantly riskier than interest-bearing accounts. They may not be the ideal option for funds you would need in the short term, like an emergency fund or a down payment you intend to make in the next 12 months.
An interest-bearing account allows you to make a bit of extra money while parking your cash safely. You can still access your money rather easily. The money is insured. To put it simply, you can rest assured that if you go to bed at night, the same amount of money will be in your interest-bearing account the next morning.
Both interest-bearing accounts and investment accounts can play a distinct role in your portfolio. An interest-bearing account allows you to earn extra money while keeping your money safe and offering easy access. An investment account has its place as a potential long-term option to help you reach financial goals like retirement. An IRA would be one such example of an investment account.
A trusted financial advisor can evaluate your assets and help you come up with a portfolio that incorporates both interest-bearing and investment accounts.
An interest-bearing account is worthy of your consideration, though the ultimate answer to this question depends on your financial situation. The money you earn in an interest-bearing account depends on three things:
Length of time the money is in the account
Overall account balance
You probably won't earn a ton of money in an interest-bearing account. For instance, if you have $1,000 in an account with a 0.31% rate of return that compounds monthly, your balance will be $1,003 at the end of the year.
You could earn more by putting your money in a high-yield savings account with an online bank, but you'll be limited to how many transfers and withdrawals you can make per month. You may also have difficulty depositing cash into the account since no brick-and-mortar locations exist. You will only be able to fund the account via transfer or direct deposit.
While every financial situation is different, interest-bearing accounts can be useful if you need to keep cash safe for some point down the road. An example would be a rainy day or emergency fund. You’d want to avoid exposing this money to market fluctuations, so you probably wouldn’t want to put it in an investment account.
But there also won’t be a high turnover on these funds, so you don't need immediate access. This means you probably don't need to keep the funds in a checking account. Putting this money in an interest-bearing savings account allows you to add to the balance via interest payments while also guaranteeing the money is accessible when you need it.
Interest-bearing accounts can potentially play an important role in your portfolio and asset management strategy. By putting your money in an interest-bearing account, you earn a small sum of money simply from allowing your cash to sit in the account. Not taking advantage of an interest-bearing account means you miss out on potential gains.
Interest-bearing accounts are just one part of your financial journey. If you’re looking for more money management tips, you can sign up for the Tally† newsletter. Each edition offers financial tips that can potentially help you manage debt and tackle your financial goals.
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