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How Debit Cards and Account Balances Affect High-Yield Reward Checking

In this interest rate environment in which savers are punished with low deposit rates and spenders are rewarded with low interest-rate loans, at least we have reward checking accounts which allow savers to profit from spenders. If everyone with reward checking accounts maintained a $25K balance and spent only $50 a month with their debit cards, we would be in trouble. Fortunately, the average reward checking customer maintains a smaller balance and spends more, and it's the average customer who drives what rates banks can offer. So thanks to the average Joe's who spend a lot and maintain small savings, banks can afford to offer high yields on the reward checking accounts.

I thought it would be interesting to see how much debit card purchases and low average checking account balances can help pay for the reward checking yields. Interchange fees are what makes the debit cards profitable for the banks. In this post, I'll look into the issue of interchange fees, and review what may change with the new financial reform regulation.

Reward Checking and Interchange Fees

The main features of a typical high-yield reward checking account are:

  1. Requirement of between 10 to 15 debit card purchases a month
  2. High rate only applies to balances of around $25K

Reward checking accounts also require e-statements and direct deposit or ACH debits. E-statements are often mentioned by banks as an important feature that allows them to pay high interest. I find it hard to believe e-statements help that much. Internet banks like ING Direct have done this for years. Their rates are higher than brick-and-mortar rates, but they are much lower than most reward checking accounts.

I think banks de-emphasize the revenue they get from interchange fees since they're not an example of improved efficiency like e-statements. Interchange fees are paid by the merchants when we make purchases with a debit or credit card. These fees are indirectly paid by all of us in the form of higher prices.

The profits from interchange fees are at risk due to the recent financial reform legislation that became law. Debit card fees will be regulated by the Federal Reserve to ensure the fees are "reasonable and proportional to the processing costs incurred." The regulation will only apply to institutions with assets of at least $10 billion. This exclusion didn't prevent small banks from opposing this bill since they feared it would indirectly force them to accept smaller fees. There are still many unknowns. The Federal Reserve will have to develop plans to regulate these fees, and then we'll have to see how it trickles down to the small banks and credit unions.

As is it now, interchange fees from debit cards still provide banks a lot of revenue. Here's an example provided at Wikipedia

For one example of how interchange functions, imagine a consumer making a $100 purchase with a credit card. For that $100 item, the retailer would get approximately $98. The remaining $2, known as the merchant discount and fees, gets divided up. About $1.75 would go to the card issuing bank (defined as interchange), $0.18 would go to Visa or MasterCard association (defined as assessments), and the remaining $0.07 would go to the retailer's merchant account provider.

Effect of Debit Cards and Checking Account Balances

In short, the more customers spend with their debit cards and the smaller the average checking account balance, the higher the yield banks can pay. Here's a basic equation that shows how the reward checking account interest rate can be affected by the monthly debit card purchases, the interchange fee percentage and the checking account balance.

Extra rate from debit cards = 100 x P x F x 12 / B

P = Average monthly debit card purchases for all customers
F = Average interchange fee percentage paid by retailers to the banks
B = Average balance maintained by all customers who meet monthly requirements

It's important to note that this is based on the average customer. A few customers may buy very little and maintain a balance right at $25K. Fortunately for us, they are not typical. Most customers have balances well below $25K and spend a lot more money with their debit card. Data that I received from a credit union in 2009 had one example of what can be considered average. In that case it was a balance of $7,700 and total monthly debit card purchases of $900. NetBanker cited data from BancVue in 2008 that showed the average balance is $9,000.

In the table below I plugged in some reasonable checking account balances and monthly total debit card purchases. I assumed banks get 1% from the interchange fee. Unlike interest rate, this is not annualized. It's a percentage of the monthly purchases. A 1% fee may be a little low, but it can make up for other factors that would hurt the checking interest rate like when customers make PIN-based purchases which typically have a much smaller interchange fee.

How Much Debit Card Purchases Help Reward Checking Rates

Avg Monthly Debit Card Purchases $5,000 Avg Balance $10,000 Avg Balance $20,000 Avg Balance
$100 +0.24% +0.12% +0.06%
$500 +1.20% +0.60% +0.30%
$1,000 +2.40% +1.20% +0.60%
$2,000 +4.80% +2.40% +1.20%

If we assume that without the help from debit card purchases, a bank would only be able to pay an interest rate of 0.50% on its checking account. We would then add 0.50% to the rates above to estimate the reward checking rates that banks can pay based on average balances and average monthly debit card purchases. One example from the above table shows that if customers spend on average $1,000 per month and maintain balances of only $5,000, the bank should be able to pay an extra 2.40% on its reward checking account. If the base rate is 0.50%, that would make for a total reward checking rate of 2.90%.

Other Factors

There are many other factors that come into play that will affect how much the bank will be able to pay in interest. It should also be noted that most reward checking accounts refund ATM surcharges. This costs banks money, and that means a lower interest rate. Below is a list of some of these factors that affect reward checking rates.

What can put downward pressure on interest rates

  • Those who receive ATM fee refunds
  • Those who make PIN-based debit card purchases

What can help banks offer higher interest rates

  • Those who overdraft their accounts (This will go down due to new regulations)
  • Those who fail to meet the monthly requirements
  • Customers who use the banks for loans and other services

The references below can provide some more insights into the math behind reward checking:

If you don't care about the math and just want the high rates, please refer to the reward checking section of which lists the best reward checking accounts that are available nationwide and for your state.

flat_broke   |     |   Comment #1
i have two rewards checking accounts.  i live alone so i dont spend a lot.  i average about $100 worth of debit card purchases on each account per month.  both accounts are fully funded for max interest.  i try to avoid tiny purchases (under $3) to avoid any wrath from the bank.... but, still, i'm only buying things i genuinely want and/or need. 
767   |     |   Comment #3
The banks probably hate people like me. I keep close to the max balance and make multiple small charges per month, usually < $5 per transaction.
51hh   |     |   Comment #4
It is a smart formula.  One additional factor tht I want to highlight is how the RCA banks untilize such deposits (most likely for loans) -- Item 3 of offering higher interest.  That may be the major factor for banks to offer 4-5% APY for their RCAs.  This important factor should be incorporated into your formula.  Say the bank can give out loans of 6% interest, with a profit margin of 2%.  Even with the lowest (near-zero) nterchange fee gain scenario, 4% APY is possible!  This is banking 101, borrow low and lend high.
mrvirgo   |     |   Comment #5
I maintain three RCA accounts. To achieve 12 charges per account per cycle, I split up my purchases at the check out counter an do two small buys instead of one large one. This helps meet my quota of 12 charges. Also self check-out stores keep me from being too embarassed as I pay for one small item. 

I keep the maximum balance and spend as close to the interest earned for that cycle as I can. Fortunately, my bank seems laxed about the dollar amount per purchase; after three years with them, I've never heard a word of complaint about some of the tiny  buys (i.e. 99cents). I guess they're glad to have my 90k earning them big bucks while they pay me chump change per month in interest.
flat_broke   |     |   Comment #7
to glen to glen:  my comment was not as serious as you took it.   my concern is simply the bank sending me a notice to increase my debit card use.... which some banks (as reported on this website) have done.  the interest i'm earning is too good to mess with in this horrible interest environment.
Anonymous   |     |   Comment #10
A note to #767 (#3) :

People like you will eventually hurt ALL OF US and YES incl. you. Don't tell me that you really DON'T have to spend more. "CUSTOMERS" like you should be kicked out from having a RCA acct.

You probably think thet you're "SMART". YOU'RE NOT. Like I said it can HURT YOU at the end.

I HOPE IT WILL and you'll learn a lesson of FAIR BUSINESS PRACTICE. I also hope that you have family members or friends that work for banks?CU. that offer RCA accts. and just maybe because of YOUR ABUSE of the system might LOOSE their jobs. Have that on your "SMART" practice.
rjm   |     |   Comment #20
#10 needs to chill out. I never made a purchase for more than $5-6 with a rewards cking card. Often they are for 4-7 cents each.

If they want to change the rules, they are free to do so. In the meantime, it is totally legal & ethical to do what Im doing.


By the way, when a bank cancels a deposit and I fail to meet the requirements, its too bad for me. Its too bad for them if my total purchases for the month is $15.
flat_broke   |     |   Comment #13
to Anonymous:  i buy what i need to buy and split it over 2 accounts.  i rarely make a purchase under $3, and never split one store visit into 2 debit cards. 

there are people who seriously abuse the system.... like making ten 89 cent purchases. i dont do that.  i was told by my credit union, people were opening 4 RCAs at a time.  so they changed the rules to only 1 account per customer. 

ultimately the federal government's financial reform act will be the death of reward checking accounts... government regulation will do far more harm than a small percentage of people who abuse RCAs.
51hh   |     |   Comment #14
Anon #10: You may be correct that small debit transactions may hurt the banks in offering high-rate RCAs.  But it is a bit extreme to state that those small purchases would cause bank lay-offs, etc.

Let us look at the issue objectively and calmly.  When banks offer RCAs, they must have done financial homework to determine their rules and regulations.  Banks do not do business that would lose money for them.  So in a reasonable statistical model, there are a certain percentage of people who do fair debit purchases (say $10 per transactions) and keep an average of $10,000.  Thus the majority of the RCA banks are happy with that, no to mention many would fail to meet the requirements monthly.

For those banks who are sensitive to small debit transactions, they usually threaten to close accounts as warnings or they simply impose a minimum for debit transactions.  Some choose to be vague (e.g., use as primary checking) to avoid issues with federal regulations.  Anyhow, they are certainly not shy in dealing with the issue.

Like I said before, banks usually gain profit margins in RCA through lending the RCA deposits timely and effectively.  The small interchage fee is just a small portion of their earning in RCAs.

We are all customers for the banks, why criticize one another when the banks are certainly looking out for themselves?  The average of $5 per debit transaction is certainly reasonable since several RCAs (e.g., Royal Bank of Missouri and Randolph Bank) impose that lower limit.  There is nothing wrong if one abides the bank rules and regulation.   

drjoanv   |     |   Comment #15
This is slightly off topic but  HOW DOES ONE LOOK UP THE RATING FOR A BANK OR CREDIT UNION USING THE DEPOSITACCTS.COM    site   RATING????     That is, one with the "Texas ratio" etc.


Thomas   |     |   Comment #22
Any one experienced with having your account closed because you spend too little? I just got a Bank of the Sierra account and I would like to avoid that! (So maybe I will intientionally fail to fulfill all reqs when I don't spend "enough").
51hh   |     |   Comment #23
Thomas (#22): BotS is not fussy at all on small debit transactions, although their APY has dropped too much for my applications.  No need to fail intentionally for BotS.
Anonymous   |     |   Comment #24
to 51hh, where do you get 4% in anRCA today, and if you do its maxed at $10,000. I use farmers and and they give 3.25% UP To50K!! Mine beats yours!! Also I use Patriotbankfl. com and they pay 3% UP TO 35K. Again i beat you . With your 10K @4% you are losing $$.
51hh   |     |   Comment #26
#24: I am never good at competing, so first, you must know what you are doing, congrats.

I have at least 10 RCA candidates with APY at 4% or above (some are inactive at 4.5% and 4.01%; even some at 4.75% - 5%), most are for $25K (none at $10K).  One has to do research for oneself to find the hidden gem.  As an example, one bank offers me 4.01% APY at $100K per account (and I have two).  Unfortunately those were grandfathered accounts one can no longer open.  One can hardly compare RCAs with CDs due to fund liquidity and maturity handling.  And again, I do not like to compete:-)  Thus my benchmark (lower limit) is $200K at 4% (and $75K (three accounts at $25K) at 4.5%, $100K at 4.75%, etc.).

(May I suggest take a look at Ken's nationalwide RCA table?  You can get a much better deal with RCA vs. the multi-year CDs)

Again, who is competing?  We are all just "humble" investors:D


Thanks much #25 for speaking for me:-) 
Mark   |     |   Comment #27
A BETTER OPTION - Forget the interest.  You can earn 3% on all your non-pin debit card purchases for the next 90 days in the form of a rebate.  PERKSTREET doesn't pay interest on the funds in checking but just transfer in enough to cover what you're going to spend for the next few days.  After 90 days you'll still earn 2% in CASH (or coffee or Amazon, your choice) any day you start with $5000 in your checking account.  This is still a much better use of $5000 than earning 4% per year.  YOU MUST ENTER 3156374405 in the reference code section of the application to earn 3% for 3 months instead of 2%.
drjoanv   |     |   Comment #29
Would any posters here care to share their RCA's with the rest of us?
Anonymous   |     |   Comment #30
i want to automate all debit card purchases through my own online store and purchase nothing from myself as well as giving myself one direct deposit per month from my own payroll also automatically per month so i dont have to do anything but log into my rca once a month.  as long as the banks are paying, i am taking so the less work i have to do the better.  anyone know of any websites that let you automate everything?

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