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Checking vs. Savings Account: Which One Do You Need?

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When it comes to choosing between a checking account and a savings account, there’s always a question of “Why?” or “Do you need one or both?”. The answer is both. Each serves a different purpose and can help you manage your funds effectively. 

Just the Nuggets

  • While a checking account helps you manage your everyday payments like bill payments, buying groceries, or taking money out of an ATM, a savings account is a long-term investment that can help you stash away some cash for a rainy day.
  • Also known as current accounts, checking accounts are traditionally associated with a credit or debit card, a checkbook, e-banking, and a mobile app meant to make your payment experience seamless, wherever you are.
  • By comparison, savings accounts operate according to specific bank-imposed restrictions that do not allow you to withdraw funds at any time. They are meant to generate long-term profit. 

Checking Accounts Explained

A checking account is a deposit account, held at a financial institution, that allows you to deposit and withdraw funds at specific dates and according to specific terms. Also known as demand or transactional accounts, checking accounts are generally very liquid—you always have funds and can access them using checks, automated teller machines, or electronic debits. 

In general, a checking account differs from other bank accounts in that it enables frequent withdrawals and unlimited deposits, whereas savings accounts, for example, have certain limitations on both.

However, while checking account holders can enjoy an unlimited number of transactions, maintaining a checking account does not offer its beneficiaries the advantage of accrued interest on their deposits. 

Types of Checking Accounts

Checking accounts include business accounts, student accounts, joint accounts, as well as other account types offering similar features. 

1. Business Checking Accounts

These accounts, having a commercial purpose, are the property of their owning business. This means company officers and managers are authorized to sign checks as empowered by the company’s governing documents.

2. Student Accounts

Subject to different terms, these usually come and remain fee-free until the account owner graduates. 

3. Joint Accounts 

These are usually accounts held jointly by two or more individuals—often spouses—where they enjoy the right to write checks.

How Checking Accounts Work

Delving deeper into the way checking accounts work, it’s important to stress that checking accounts do not offer high interest rates—if hardly any—in exchange for liquidity (withdrawable cash available in the account balance). 

Nevertheless, if you hold a checking account in a chartered banking institution, any funds you have in the account are guaranteed or safeguarded by the Federal Deposit Insurance Corporation (FDIC), the Investor Compensation Fund (ICF), or other Investor Protection Committees (IPCs)—as the case may be—up to a standard amount of $250,000 per individual depositor per insured bank.

Most importantly, for accounts with substantial balances, banks offer an option to sweep the account. This is essentially withdrawing most of the excess cash in the account and investing it in overnight interest-bearing funds. At the beginning of the following business day, the funds are deposited back into the original checking account with the overnight interest.

Bank Strategies and Checking Accounts

Numerous banking institutions charge minimal fees on checking accounts. It is known that the largest commercial banks use checking accounts as loss leaders. 

A loss leader is typically a marketing tool a company uses to offer one or more products below the actual market value to attract consumers. The goal of banks is to attract clients with free or low-cost accounts and then lure them with more expensive offers such as mortgages, personal loans, or certificates of deposit.

But don’t forget, alternative lenders such as fintech companies are gaining more market share, offering consumers more loans. Sooner rather than later, banks will—therefore—need to revisit their policies and potentially even increase the fees on checking accounts if they cannot sell more of their profitable products to cushion any losses.

Money Supply Gauge

Because the money in checking accounts changes hands rapidly—hence its liquid quality—aggregate balances nationwide are used to calculate the M1 money supply. 

M1 refers to the total amount of all transaction deposits held at depository institutions (banks, investment firms) and publicly-held cash. M2 is another money supply gauge, which includes all the funds included in M1 and those in savings accounts, small time deposits, and retail money market mutual fund shares.

How to Use a Checking Account

To deposit money to a checking account, you can choose from several methods including direct deposit, ATMs, and over-the-counter (in person) deposits. Similarly, to access your funds, you can use your credit/debit card, checks, or ATMs.

Digital technology has made the use of checking accounts increasingly convenient. You can now easily pay bills via e-banking transfers, thus eliminating paperwork. To make your payment experience even smoother, you can also set up direct debits for recurring payments, as well as use your smartphone to make transfers and deposits.

However, it’s vitally important not to overlook account management and overdraft fees, which are not advertised but rather specified in the fine print at the bottom of each account statement or on the bank’s website.

Overdraft Protection

An overdraft occurs when you make a purchase for a value exceeding your account balance and the bank covers the difference. This is a type of credit line known as overdraft protection.

What most banks don’t tell their customers is, they charge a hefty fee for each payment that exceeds their account balances. For example, if your account balance is $50 and you make repeated payments of $25, $25, and $57, you will be charged an overdraft fee for the last payment—which exceeded the amount of cash available in your account—and also for any subsequent payment after you’re in the red. 

But this is not all. In most cases, as per the account holder agreement, the bank groups the transactions according to size in case of an overdraft. So, taking the example above, the bank will charge a fee for every transaction in the order of $57, $25, and $25. Additionally, if the account remains overdrawn, the bank may also charge daily interest on the loan. 

This is why it’s very important to always check the bank’s overdraft charges and read the small print before you commit to anything. Alternatively, if you wish to avoid overdraft charges, you can always opt out of the overdraft coverage by choosing an account with no overdraft fees instead or keeping your funds in a linked account.

Service Charges

Service charges, such as handling fees and transfer fees, vary from bank to bank. While generally, banks are thought to generate income from charging customers interest on loans, service charges are yet another way of creating an income stream from accounts that aren’t generating enough interest to cover the bank’s expenses. 

In today’s digitally-enhanced financial setup, it costs a bank just as much to maintain a micro-account with a $10 balance as it does an account with a $2,000 balance. The difference is, while the larger account generates enough interest for the bank to earn some income, the $10 account is instead costing the bank more money than it is bringing in. 

Direct Deposit

A direct deposit is a feature that allows your employer or someone else to electronically deposit cash to your account and makes the funds immediately available. Banks also take advantage of this feature as it generates a steady cash flow. Many banks offer free checking (no minimum balance or monthly account maintenance fees) if you activate the direct deposit feature on your account.

Electronic Fund Transfers

Electronic fund transfers (EFTs) are typically known as wire transfers that allow direct money transfers to and from your checking account without having to wait for the check to arrive in your mailbox. Most banks today don’t charge for EFTs.

ATMs

Automated teller machines (ATMs) offer you ultra-convenient access to your cash. However, depending on the user agreement and the bank’s policy, additional charges may apply. 

Cashless Payments

The debit card has become the staple for anyone using a checking account. It’s easy to use, and it takes off the burden associated with high-interest credit card bills off your shoulders. In an effort to secure your utmost data protection, many banks provide zero-liability fraud protection to help prevent identity theft if a card gets lost or stolen.

Interest-Bearing Checking Accounts

Generally, interest-bearing checking accounts come with a lot of fees, especially if you cannot maintain the balance above a certain minimum level. According to a 2020 Bankrate study, the average minimum balance required to avoid paying a monthly fee on an interest-bearing checking account is $7,550, and the monthly fee charged on an interest-bearing account hit a record high of $15.50.

If by any chance, your account balance drops below the minimum required balance, you will have to pay the monthly service fee. However, if you have a long-standing relationship with the bank, the monthly service fee on your interest-bearing checking account might be waived.

The minimum amount required to open an interest-bearing current account also skyrocketed in 2020—from $575 in 2019 to $971—as per the Bankrate survey.  

Credit Scores

In general—checking account activities, such as making deposits, withdrawing, and writing checks, do not affect your credit score (a number between 300 and 850 describing your creditworthiness) and credit report (your credit history including how many loans you have applied for and repaid, any outstanding installments or overdrafts, etc.). 

Closing a dormant checking account in good standing has no negative impact on your creditworthiness either, as long as you oversee that no transactional activity leading to your account being overdrawn appears on your credit report and take care of any such payments in a timely fashion.

Some banks conduct a soft inquiry or pull of your credit report to make sure you have a clean track record before they offer you a checking account. By comparison, if you open a checking account and also apply for a mortgage, a personal loan, or an overdraft, the bank will likely conduct a hard inquiry aimed at revealing your credit history up to 12 months. 

Hard pulls may drop your credit score by as much as 5 points. If you fail to restore your account to a positive balance on time, the bank will likely report the incident to the credit bureaus, blacklist you, and even turn your account over to a debt collection agency.

Opening a Checking Account

You can open a checking account either in person at a bank’s branch or electronically by submitting an online application through the bank’s website. 

Apart from credit bureaus, there are also agencies keeping track of and reporting your banking history to banks. When you apply for a checking account, the bank you’re applying to may ask for a consumer banking report, which is basically an account of your whole banking activity, including any bounced checks, late payment fees, etc. Based on this report, the bank may grant or reject your account opening request.

Pros

  • Easy access to your funds through a variety of media: debit card, e-banking, mobile banking, ATM
  • Sign-up bonuses of $100 – $500

Cons

  • Monthly maintenance fees (i.e. ATM withdrawal fees, in-bank transaction fees, wire transfer fees, over-the-phone transaction fees, etc.)
  • Overdraft fees
  • ATM withdrawal limitations (sometimes)

Savings Accounts Explained

Savings accounts are interest-bearing deposit accounts held at a bank or investment management firm. Although these accounts pay a modest interest rate, they are a safe investment option for both your short-term and long-term goals.

However, savings accounts come with a number of limitations on how often you can withdraw funds. According to Federal law, until April 2020, the number of withdrawals you could make in a month was up to 6. It is still unclear if this situation is permanent.

Regardless, savings accounts offer great flexibility that’s ideal for setting up an emergency fund, saving for a rainy day or a short-term goal like buying a car or going on vacation, salting away the down payment for a home, or just sweeping the extra cash you don’t need in your checking account so it can earn overnight interest elsewhere. But remember, the interest you earn on your savings is considered taxable income.

Types of Savings Accounts

There are six types of savings accounts you can choose from, according to your goals.

1. Regular Savings Accounts

These are suitable for people who want to save funds for a short or long period but are less concerned about getting the best interest rates.

2. High-Yield Savings Accounts

These are suitable for individuals who are looking to earn the best possible interest rates while saving on fees.

3. Money Market Accounts (MMAs)

These are a hybrid between checking accounts and regular savings accounts and are suitable for people who want to earn interest on their savings while also having easy access to their money.

4. Certificates of Deposit (CDs)

These are time deposits and are ideal for people who want to earn interest on their savings and do not need to access their funds immediately.

5. Cash Management Accounts

These are suitable for people who want to dispose of their cash to invest in their brokerage or retirement account.

6. Specialty Savings Accounts

These are suitable for individuals who want savings accounts tailored to their specific goals (personalised savings accounts).

How Savings Accounts Work

Savings accounts are a good source of cash that financial institutions can spin and lend to individuals or businesses. For this reason, pretty much every bank or credit union (a financial cooperative that provides traditional financial services) offers savings or deposit accounts—whether they are brick-and-mortar institutions or exclusively online-based financial institutions. In addition, investment management firms and brokerages also offer savings accounts.

The rate you can earn on a savings account is variable. Apart from promotions promising a fixed rate until a specific date, banks and credit unions can raise or lower the interest rate at any time. Some financial institutions offer exclusive high-yield savings accounts which are worth exploring.

Opening and maintaining a savings account does not require a lot of money. You can start with a small amount and let it grow. Many savings accounts are also insured by FDIC, other Investor Protection Committees, or related organizations around the world responsible for safeguarding investors’ funds against fraud or theft. 

In case of an emergency, you also have an option to automatically cash out for an unforeseen expense. To move money in or out of your savings account, you can do it through an ATM, wire transfer, or direct deposit. Transfers can also be scheduled or arranged by phone.

Pros

  • Variable amounts of interest income on deposits
  • Ability to withdraw funds in case of an emergency
  • Automatic deductions for ill payments
  • Low-to-moderate initial investment
  • Fund protection

Cons

  • Lowest return on investment compared to other forms of investing
  • Minimum balance requirement
  • Charges if the account balance drops below the required level
  • Fund insurance only up to $250,000 (FDIC)

Do You Need Both Accounts?

Both checking and savings accounts offer you advantages that can ensure your long-term financial health. 

A checking account should be perceived as an everyday transaction account, mainly as a place where you’ll be paying your monthly bills from—gym or other subscriptions, groceries, and other purchases. As a precaution, a checking account should have a cushion. After settling your regular payments, transfer the remainder to a savings account where it will accrue interest.

Having said that, maintaining a savings account is important because it allows you to grow your money effortlessly. Although the interest you can earn may not be substantial, it is a regular steady source of income you can count on. 

Maintaining two accounts is, therefore, beneficial as it offers you more financial freedom and peace of mind—knowing you always have a cushion for a rainy day or the down payment for your dream house.

Closing Notes

Checking AccountSavings Account
MAIN USESpendingSaving
INTERESTIn some cases, but the amount is minimalYes (interest rates vary by financial institution or bank)
FEESMonthly maintenance fee
Overdraft fee
Out-of-network ATM withdrawal fee
Monthly maintenance fee
Minimum balance charge (if the balance drops below the required level)
Savings withdrawal limit fee
MINIMUM REQUIRED BALANCEVaries by bankVaries by bank
WITHDRAWAL LIMITNoneUsually 6 times per month
Source: Diffen

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