A savings account is a type of personal financial account designed to hold money that you don’t need right away. These accounts allow you to set aside part of your paycheck while earning a small amount of interest on your deposits.
To give you some idea of what you can earn on a savings account, use the free tools available at MoneySupermarket compare savings accounts.
How do savings accounts work?
Your bank pays you money to keep funds in an account. Your payment comes in the form of compounded interest, which simply means that they pay you interest on your interest.
For example, if your savings account earns 2% interest, the bank adds 2/365 of the amount of money in your savings account to your grand total each day. Two percent might not sound like very much, but it really adds up in the long run.
How do the banks make money?
If the bank pays you to keep your funds there, how does it make any money? This can be explained in a three-part answer.
First, you open one of many online savings accounts at the financial institution of your choice. Whenever you open an account, the bank guarantees that you will receive a specific amount of interest.
Then the bank loans out your money to other individuals in the form of loans or mortgages. The bank charges those individuals a higher percentage of interest than they pay out to you.
Finally, the bank keeps the difference between what they receive from the other individuals and what they give you. For example, if your savings account earns 2% interest and they use your money for a mortgage that gets 9% interest, the bank gets to keep that 7% difference.
What are the most common types of savings accounts?
Banks typically offer two kinds of savings accounts, namely basic savings accounts and Money Market accounts. Basic savings accounts, often referred to as passbook savings accounts, typically have a low or no minimum balance requirement.
You usually have access to your deposited funds without any limitations. This means that you can easily withdraw money whenever you are short of cash.
Money Market accounts typically require a higher minimum balance than basic savings accounts. You must also be willing to leave your deposited funds alone for a specific amount of time. Once that time has passed, you can then withdraw your money without penalties.
Money Market accounts generally pay higher interest rates than basic savings accounts. The more money you keep in a Money Market account, the higher rate of interest you will earn in return.
What are the benefits of a savings account?
Savings accounts give you a safe place to stash any extra cash that you don’t need to use for a while plus you will receive a return on your deposits. Savings accounts typically earn slightly higher interest rates than checking accounts.
Although savings accounts usually offer lower interest rates than other investments, your deposits are still quite liquid. Basic savings accounts allow you to withdraw your funds pretty easily, which is why they are often referred to as “near money” accounts.
Savings accounts are considered a no-risk investment because your funds are insured by the federal government should the financial institution fail.