How Online Savings Accounts Work

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Make money on money that's just sitting around -- that's the basic premise of a savings account. You put money in a bank. The bank lends your money out to other people and businesses in the form of personal and business loans, charging the borrowers interest on what they owe until they pay back the money. Meanwhile, the bank pays you interest for the privilege of lending your money.

­The all-powerful Internet has vastly changed the world of banking, but not its underlying premise. Online banking still operates on the principles of lending, saving and earning. But the advent of online-only banks -- banks that exist solely on the Internet and don't have brick-and-mortar branches -- has created great competition for traditional banks. Online-only banks may offer higher interest rates on savings and investment accounts. But although they make banking very convenient and versatile, online-only banks face their own problems and challenges.


In this article, we'll examine one piece of the world of online banking, the online savings account. First off, let's see how an online savings account compares to a traditional savings account.



Online Savings vs. Traditional Savings

Wanted poster for Pretty Boy Floyd
Bank robbers no longer need guns and masks like "Pretty Boy" Floyd did. Online banks must constantly defend their virtual vaults against clever hackers.
Mark Perlstein/Time Life Pictures/Getty Images

There are several important differences between traditional savings accounts and online savings accounts.

Let's take the case of Joe, who is perfectly happy with his traditional savings account. He likes the assurance of dealing directly with human beings, handing his deposit slip and checks to a living, breathing person standing behind a counter in an actual building. Furthermore, Joe likes his ATM access. When he uses his bank's ATMs, he can withdraw straight from his savings account if he needs to, and he pays no fees to do so.


The low annual percentage yield (APY) of 0.25% on his savings account isn't amazing, but he has other investment accounts to develop his savings.

Joe has never let his savings account dip below the $500 minimum -- he's afraid of that $6 monthly fee that threatens to eat his account if it does go that low.

Joe is glad he doesn't need to remember all sorts of passwords and other rigmarole to look at his statements, which simply arrive in the mail. But, of course, he still shreds old statements and banking info. You can never be too careful.

On the other hand, we have Sally, who recently closed her traditional savings account and opened a high-yield online savings account. The APY of her online savings account started at 3%, an enormous increase over her 0.5% APY on her traditional savings account. This high APY, competitive with that of money market accounts, makes her savings account more suitable for a long-term investment. Curious as to why the APY on her savings account is so wonderfully high, Sally does some research and discovers that online-only banks can charge fewer fees, require no minimum balance, and offer great interest rates because they don't have the wage, maintenance and real estate costs associated with brick-and-mortar branches.

Sally enjoys the convenience of viewing her statements online at any time. She can also initiate electronic transfers to and from her traditional checking accounts whenever she wants -- at 2:30 in the morning, for example, when she wakes up and remembers she has to pay for some car repairs in a couple of days. To increase her savings, Sally has set up a recurring transfer of $100 per month from her traditional checking account to her online account.

Sally isn't always thrilled with her online savings account, however. Her online bank partners with a traditional bank to provide ATM access, but she has to pay a fee every time she uses one of these affiliated ATMs. She can't make deposits through these ATMs, only withdrawals. For deposits, she must mail her check to the online bank's office, or deposit the check in her traditional checking account and then transfer the money electronically to her savings account. Unfortunately, her savings deposits take a while to clear.

As for security, her bank's Web site is encrypted. These days, 128-bit encryption is the standard. To access her account, she enters her login on the first page and her password on the second page. A little bit of a speed bump, but not bad.

Intrigued by online savings accounts? Read on to find out how to get one.


How to Get an Online Savings Account

E*Trade Financial sign
Some online banks, like E*Trade Financial, allow you to link your bank accounts to your investment accounts.
Scott Olson/Getty Images

The savings account application processes at HSBC, Virtual Bank, E*Trade, ING Direct, EverBank, EmigrantDirect and any other online bank are pretty similar and fairly simple. Traditional banks that offer online banking have similar processes, although some may require you to apply on paper.

To open an online savings account, you visit the bank's Web site and click a button that says something clever like "Open an Account." Then you proceed to fill out the bank's online application. If you prefer, many online banks can provide a paper application for you to fill out and mail.


Online bank applications will ask for the following information:

  • address
  • personal and work phone numbers
  • date of birth
  • Social Security Number or Tax Identification Number
  • ID number, such as a driver's license number, and expiration date

The application will also ask you for a login name and a password. Memorize your login and password, or write them down and store them in a safe place.

As far as security goes, online banks need information to verify your identity. Many banks, such as EmigrantDirect, ask for a previous address and your mother's maiden name. Other banks, like Virtual Bank and ING Direct, ask you to choose security questions, such as, "What is your favorite pet's name?" You provide the answers to these questions. When the bank needs to confirm your identity -- when you log in, for example -- the bank will ask you one of these security questions.

Online savings accounts link to traditional or online checking accounts. To establish a link to your checking account, you enter your bank's routing number and account number in the online application form. Once your savings account is open, you can transfer money between the linked accounts.

Some banks, such as ING Direct, take an extra security step when you establish this link. The bank will deposit into your linked checking account two amounts of less than $1. You enter the value of these deposits on the online bank's Web site. This theoretically confirms your identity, since only you should have access to your account's transaction records.

Interested in starting an account? Most online banks require only a very small opening deposit (a whole dollar for HSBC). Whatever the minimum amount, this opening deposit comes from your linked checking account. If you are applying on paper, you can include a check in the envelope with your mailed application.

To choose the best online bank for you, consider the following points:

  • Account APY: These vary from day to day and from bank to bank. Some are just introductory rates. Read the fine print.
  • Customer service: Will you be able to talk to a live person when you really need one?
  • Fees and service charges: Most online-only banks have done away with fees. But, again, read the fine print.
  • FDIC insurance: Be wary of online banks (or any bank, for that matter) that isn't insured by the FDIC.

If you'd like to know more about online savings accounts and other personal finance topics, you can follow the links to articles on the next page.


Lots More Information

Related HowStuffWorks Articles

More Great Links

  • Bank of America. (Accessed 5/9/08)
  • ConsumerSearch. "Online Banking." 2008. (Accessed May 9, 2008)
  • E*Trade Financial. "Free Quick Transfer." (Accessed May 9, 2008)
  • E*Trade Bank. "Save to the Max." (Accessed 5/8/08)
  • EmigrantDirect. "4 Easy Steps to Apply." (Accessed 5/8/08)
  • EmigrantDirect. "Frequently Asked Questions (F.A.Q.)." (Accessed 5/8/08)
  • EmigrantDirect. (Accessed 5/8/08)
  • FDIC. "Failed Bank Information, NetBank, Alpharetta, GA, Closing Information." (Accessed May 9, 2008)
  • HowStuffWorks. "How do savings accounts work?" April 14, 2008. (Accessed May 8, 2008)
  • HSBC Direct. "Online Savings Account: The Breakdown." (Accessed 5/8/08)
  • ING Direct. "Orange Savings Account." (Accessed 5/8/08)
  • ING Direct. "Orange Savings Account." (Accessed 5/8/08)
  • Investopedia. "Annual Percentage Yield (APY)." (Accessed 5/8/08)
  • Investopedia. "Savings Account." (Accessed 5/8/08)