Why Some Checking Accounts Have Higher Rates Than Savings Accounts

A reader asked an interesting question in the discussion forum of why some checking accounts pay higher interest rates than savings accounts. Cases like this are becoming more common.

Examples of Checking Accounts with Higher Rates

The reader pointed to Incredible Bank which offers an internet checking account that pays 0.93% APY for balances up to $250,000 (as of 5/8/2012). As you can see in our savings account table, this yield is higher than the yields of most of the internet savings accounts. However, it's a little lower than Incredible Bank's money market account which pays 1.00% APY for balances up to $250,000. Unlike the checking account, Incredible Bank's money market account has a monthly service charge if the balance falls below $2,500.

There are other examples with checking accounts with higher interest rates than savings and money market accounts. One is at ING Direct. For large balances, ING Direct's Electric Orange (EO) checking account has a yield higher than the Orange Savings Account. The EO account pays 0.90% APY for balances of at least $100K and 0.85% APY for balances from $50K to under $100K. The Orange Savings pays 0.80% on all balances. So if you have a large balance, you'll want to open the EO account to maximize your interest. You can even make more money in this checking account than in most of ING Direct CDs. Only the 5-year CD has a higher interest rate (1.00% APY as of 5/8/2012).

At Bank of Internet USA, the Rewards Checking account has a yield up to 1.25% APY on all balances (as of 5/8/2012). The highest savings account rate is only 0.80%.

Debit Cards Help Pay for the Higher Rates

The checking at Bank of Internet USA is not the typical checking account. It's a reward type checking account that requires certain activity to qualify for the high rate. We have seen similar reward checking accounts at many community banks and credit unions (see post). The main requirements for reward checking accounts are debit card purchases. That's one important reason why banks can pay higher interest rates on checking accounts. Each time you use your debit card, the merchant pays an interchange fee to the bank. The more you use your debit card, the more interchange fees go to the bank.

Even for the checking accounts at Incredible Bank and ING Direct that don't require debit card purchases, I'm sure some customers still make purchases with their debit cards.

Another way banks make money from debit card usage is from overdraft fees. It has been shown that when people use debit cards more, they will have more overdrafts. This might not be true for those of us with large savings, but for the average Joe who lives paycheck to paycheck, it has been shown to be true. Most banks charge large fees each time the customer has an overdraft. Even with the new regulation that requires customers to opt-in for overdraft protection, many customers choose to opt-in without really understanding that it will cost them (see post).

Reserve Requirements and Transaction Costs

If you exclude reward checking accounts and a few special cases like Incredible Bank and ING Direct, you will find that most banks do offer higher interest rates on savings accounts than on checking accounts. This My Money Blog post has a good explanation why this is generally true. In short, checking accounts are transaction accounts which have reserve requirements. You can review the latest reserve requirements set by the Federal Reserve. Savings accounts which have transaction limitations don't have these reserve requirements. Thus, this helps savings accounts to be more profitable for banks than checking accounts.

Another way checking accounts can be more costly for banks is due to the transaction nature of checking accounts. Check processing is a cost for the banks. Also, checking accounts probably have more teller transactions than savings accounts. With the growing popularity of online bill pay and ACH transfers, fewer paper checks are written. This type of checking account cost is probably going down for banks, especially for internet banks like ING Direct.

Bottom Line

Due to reserve requirements and some additional transaction costs, we probably won't see all checking accounts offering higher interest rates than savings accounts. The fees banks get from debit cards and overdrafts go down when people have larger balances. Except for a few cases like ING Direct and Bank of Internet USA, savings accounts still generally have higher interest rates than checking accounts for large balances.

If you can think of other possible reasons why some banks like ING Direct offer higher yields on their checking accounts, please leave a comment.