Savings account and certificate of deposit (CD) rates have reached the highest levels in at least a decade. If you’re wondering what factors impact the interest rate of your bank account, let’s break them down for you.
Questions Answered in this Article
Question 1: What factors impact the rate of savings accounts and certificates of deposit?
Answer: The rate of savings accounts and certificates of deposit is impacted by factors such as the Federal Reserve’s federal funds rate, banks’ decision to raise rates, competition from online banks, the type of bank account, and economic forecasts.
Question 2: How does the Federal Reserve’s federal funds rate affect savings rates?
Answer: The Federal Reserve’s federal funds rate influences savings rates as banks and credit unions take cues from these rate increases to raise their rates on loans, savings accounts, and certificates of deposit. Higher borrowing costs due to increased Fed rates lead to higher rates offered by banks.
Question 3: Why do online banks offer higher rates on savings accounts and certificates of deposit?
Answer: Online banks can offer higher rates on savings accounts and certificates of deposit because they don’t have the overhead costs associated with physical branches. This allows them to compete for customers by providing better rates.
Question 4: What alternative investment options may offer higher returns than banks?
Answer: Money market mutual funds are one example of alternative investment options that can provide higher returns than banks. Although not federally insured like bank accounts, these funds offer relatively safe and accessible investments, typically consisting of short-term, high-quality investments such as U.S. Treasuries.
Question 5: How do economic forecasts influence bank account rates?
Answer: Economic forecasts can impact bank account rates, particularly regarding certificates of deposit (CDs). CD rates are typically fixed, and banks may adjust them based on their beliefs about future interest rate movements. For example, an inverted yield curve, indicating lower long-term rates, may lead banks to change CD rates in anticipation of rate cuts by the Federal Reserve.
Fed Rate Increases Drive Up Savings Rates
From March 2022 to May 2023, the Federal Reserve steadily increased its federal funds rate, also known as the Fed rate, from nearly zero to approximately 5%. These rate hikes are the Fed’s attempt to control high inflation. The Fed rate is the rate at which U.S. banks borrow or lend money overnight to each other, and a higher rate translates to higher borrowing costs.
In response to these rate increases, banks and credit unions raise their rates on loans, savings accounts, and certificates of deposit. Banks often utilize the money in customers’ bank accounts to fund new loans and investments, and offering higher savings rates helps attract more customers.
However, banks don’t immediately follow the Fed rate, and their rates typically remain lower. According to an analysis from April 2022 to May 2023, national average rates for savings accounts only increased from 0.06% to 0.40%, and for one-year CDs, they rose from 0.13% to 1.59%. The larger banks, in particular, often lag in raising savings rates.
Online Banks Compete with Higher Rates
National average rates don’t paint the whole picture. If you’re a diligent saver, you’re probably familiar with high-yield savings accounts and CDs. These accounts offer rates several times higher than the national average and are mainly available at online banks and credit unions. These branchless institutions don’t have the overhead costs of traditional banks, allowing them to provide and compete for customers with higher rates.
For instance, in June 2022, high-yield savings rates at some online banks ranged from 1% to 1.25% annual percentage yield (APY), while competitive one-year CD rates hovered around 1.50% to 2% APY, based on NerdWallet data. In May 2023, top savings rates have increased to approximately 4.75% APY, with some one-year CD rates surpassing 5% APY.
Consider high-yield savings accounts for emergency savings or short-term financial goals to take advantage of these rates. While rates are variable and subject to change, regular contributions will boost your savings and enable you to benefit from compound interest over time. High-yield CDs can provide competitive fixed rates that compound interest if you have a portion of protection that can remain untouched for months or years.
Other Factors Affecting Rates
The type of bank account matters. Banks tend to raise rates quickly on CDs, followed by savings accounts and money market deposit accounts, according to Federal Reserve Bank of New York researchers.
CDs lock funds for a fixed term, while savings and money market account offer ongoing access, although they may have monthly withdrawal limits. Checking accounts, which offer the most access to funds, typically earn minimal or no interest. NerdWallet analysis shows that the national average for interest checking has barely changed over the past decade.
Consumers may seek higher returns outside of banks. While banks aim to keep interest rates low to reduce costs, they must also remain competitive with other investment opportunities available to savers. Money market mutual funds, for example, currently offer relatively safe and accessible investments with high returns, although they lack federal insurance like bank accounts. These funds consist of short-term, high-quality investments such as U.S. Treasuries. Deposits may opt to move their money out of banks and into these nonbank options, which pressures banks to raise their rates to retain those customers.
Economic forecasts can also play a role in determining bank account rates. CDs are the only type of bank account with fixed rates, and typically, the longer the CD term, the higher the rate. In an ideal scenario, you are rewarded with a higher rate for keeping your funds inaccessible for extended periods. However, in the first half of 2023, the national average and high-yield CD rates experienced an inverted yield curve, similar to those with bonds like Treasuries. This phenomenon indicates that long-term interest rates are lower than short-term rates. Banks may interpret this yield curve as a signal that interest rates will likely decrease, leading them to adjust CD rates accordingly. Some experts speculate that banks may be anticipating rate cuts from the Federal Reserve as a measure to combat a potential recession.
While a rising rate environment generally benefits savers, it’s important to remember that other factors can influence the rates you receive on your bank accounts. Keeping an eye on the Federal Reserve’s actions, exploring online banks for higher speeds, and considering alternative investment options can all contribute to optimizing your savings potential.
Summary
- Rates on savings accounts and certificates of deposit (CDs) have reached highs not seen in at least a decade.
- The rate of your bank account is influenced by factors such as the Federal Reserve’s federal funds rate, banks’ decisions to raise rates, competition from online banks, the type of bank account, and economic forecasts.
- The Federal Reserve’s federal funds rate increases have led banks and credit unions to raise rates on loans, savings accounts, and CDs to offset higher borrowing costs.
- Online banks offer higher rates on savings accounts and CDs due to their lower overhead costs compared to traditional brick-and-mortar banks.
- Alternative investment options, such as money market mutual funds, may provide higher returns than traditional bank accounts, although they lack federal insurance.
- The type of bank account affects the speed at which rates are raised, with CDs typically experiencing quicker rate adjustments compared to savings and money market accounts.
- Banks have an incentive to keep interest rates on savings accounts low to save on costs but need to remain competitive with other investment options.
- Economic forecasts, such as an inverted yield curve, can influence bank account rates, as banks may adjust CD rates based on their expectations of future interest rate movements.
- It’s important to consider these factors and explore options to maximize your savings potential in a changing interest rate environment.
