Internet Banks and Rate Chasing - Is It Worth It?

I just reported on the new internet bank, SFGI Direct which is offering a no-minimum savings account with a competitive rate of 2.25% APY (see account review). A question that many people may ask is:

Is it worthwhile to open yet another online savings account? Isn't it just a matter of time that the rate will fall and be comparable to the average online savings account?

Some new internet banks offer an intro rate guarantee so you'll know the rate won't plummet in the next month (or the next day in some past cases) after you open the account (see list). If you're concerned for the long-term, even these intro rates may not mean much if the rates still plummet after the intro period is over.

How long will competitive rates last?

You may be able to get some idea of how long a bank will be able to maintain high rates by the size of the bank. A small bank that brings in 500 new customers who deposit on average $100,000 will generate $50 million in new deposits. For a small bank with total deposits of $100 million, $50 million of new deposits can easily be overwhelming. It'll be unlikely that they'll be able to make use of all these deposits through loans (especially in today's environment). For a larger bank with $10 billion in deposits, an additional $50 million in deposits only adds 0.50% to their total deposits, and it's more likely that they won't be overwhelmed and be forced to cut rates or limit availability.

There have been examples of new small internet banks keeping their rates competitive after their intro period. One example is CNB Bank Direct. They began in September 2008 with a 4.00% APY guaranteed for 6 months. The 6-month guarantee ended in October, and they still have a competitive rate of 2.00% APY as of 7/25/09 (see account review). Also CNB Bank Direct's parent, Citizens National Bank, isn't a large bank. As of March 31, 2009, it only has $565 million in assets and $418 million in deposits. In 9 months from 6/30/08 to 3/31/09, their deposits have grown from $350 million to $418 million. I would assume much of this increase is due to the online bank. This example shows that nationwide internet banks with competitive rates still don't bring in huge amounts of deposits relative to the banks' more traditional deposit sources.

An internet bank that's part of a large bank doesn't guarantee rates will stay competitive. One example is OnBank which is part of M&T Bank Corporation, one of the 20 largest independent bank holding companies in the U.S. When OnBank was launched in April 2008, it was offering a very competitive online savings account. The competitive rates lasted for much of 2008, but in the last several months, the interest rate has been a pathetic 0.50%.

So it's not easy to judge how well the rates will hold up for the long term.

Ease of moving your money

If an online bank doesn't make it easy to transfer money to other banks, there's more risk in opening an account. It's the risk of leaving your money in the account after rates have fallen because it's too much hassle moving the money to a higher interest rate account. This can be the case if the bank doesn't provide an ACH bank-to-bank transfer service.

Even if a bank does have an ACH transfer service, it can still be problematic if they make it hard to link to another account. Some banks require you to mail in a voided check if you want to create a link. In addition, some limit the number of links you can have to as little as one. Another issue can be the size of the allowed transfes. Some banks have transfer limits as low as $2,000.

Even if a bank doesn't provide an ACH transfer service, most will allow you to withdraw or deposit funds using an ACH transfer service from another bank. However, there are a few which do not allow this.

Opening too many accounts

Even when the bank makes it easy to move your money, there are issues regarding opening new accounts. Banks sometimes do hard credit pulls in the application which can temporarily ding your credit score. Also, if the bank uses ChexSystem in the application, that inquiry goes on your ChexSystem record. Some banks will reject your application if you had too many recent ChexSystem inquiries. So you may miss some future hot deal if you've opened too many accounts.

There's also a cost in time. Opening new accounts take time. Monitoring your accounts also take time. There are websites like Mint.com and Yodlee that can make it easy to track multiple accounts. But there are potential downsides to these services. If you have tips on reducing the time and effort on this, please leave a comment.

Cost of rate chasing

There's also a direct cost with rate chasing. When you initiate electronic transfers, there is often a time in the transfer process when that money isn't earning any interest. For example, you initiate a transfer at a bank on Thursday. The money may be debited from that account on Friday. It may not be credited to your destination account until Wednesday of the following week. So you may miss out on 5 days of interest.

MyMoneyBlog has a useful calculator to help you evaluate the cost of transfers.

Another issue with rate chasing is the risk of fees. Some online banks have monthly fees if your balance falls too low or if your account lacks activity after a certain amount of time. So if you transfer most of the money to a new higher interest rate account, you may be hit with fees from that old account if you don't close it or if you are not careful.

That's one benefit of having accounts without minimum balance requirements. However, don't assume requirements will remain unchanged. There have been cases in which online banks have added minimum balance requirements or raised the minimum balance requirements. Also, don't assume no-minimum literally means no minimum. I recommend keeping at least $1 in a no-minimum account. Many times banks will close an account when the balance falls below $1 even when they advertise it as a no-minimum savings account.

So are you still rate chasing? What tips do you have?

To compare high-yield savings accounts, please refer to my weekly rate summary.

Alternatives to internet savings accounts

Reward checking is an alternative to the internet savings account. But reward checking isn't immune to falling rates. To compare rates of reward checking accounts and to learn more about them, refer to my High Yield Checking website.

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