The first online bank emerged in 1995, five years after the start of the internet as we know it today. Today many traditional banks and credit unions offer ways to access your funds digitally through a website or mobile app, but online-only banks still carry important distinctions from brick-and-mortar institutions.
High interest rates
Online banks (or "internet banks") differ from traditional banks in that, with few exceptions, they don’t have physical branches to visit. The money they save from not having to maintain and staff locations results in higher interest rates for their customers.
Most online banks offer high-interest savings accounts with annual percentage yields (APYs) in the 1 percent to 2.5 percent range. To add some context, according to the FDIC the average APY for all banks is .09 percent. If you have $10,000 in your savings account, a 0.10 percent APY will earn you $100 over a 10 year span. Contrastingly, a 2.2 percent APY will earn you nearly $2,500 over the same time frame.
Some traditional banks will offer higher APYs as temporary promotional rates or have minimum balances for their money market accounts upward of $10,000 to qualify. Online banks have lower or no minimum balances and sometimes even offer an interest rate on your checking account, a feature very rarely seen with brick-and-mortar banks. Interest-bearing checking accounts help you earn interest on every dollar you have, without tying up your money. Online banks also offer other investment options such as certificates of deposit or money market accounts.
Low monthly fees
Due to their lower overhead costs, online banks typically have lower monthly maintenance fees than other financial institutions. Traditional monthly fees look like a $5 or $10 charge to use your account if you don’t meet certain minimums or requirements. Many online banks wave these fees altogether.
Easy to sign up
You can sign up for an online bank account from the comfort of your home. Most online banks require little paperwork. For American citizens, many require a social security number and photo of your driver’s license.
Access from anywhere
Online banks add convenience as you can completely control your money from wherever you are. Mobile banking apps help you access your funds from anywhere.
Online money transfer
Due to their design, online banks work well for wire transfer of funds, direct deposits, online bill pay, and other online transactions. Some online banks have options to use checks, though this may be more limited than traditional banks.
Credit and debit cards
Most online banks offer credit and debit card options to access your funds. Though your money is kept digitally, you won’t have any problems using it for purchases.
No physical locations
As mentioned above, most online banks exist strictly online. This creates difficulty for cash deposits and face-to-face assistance, and depending on the bank, perhaps limited ATM access as well. Some online banks have their own ATMs, while others partner with the ATMs from third-party banks, and some online banks provide no ATM access at all. In this case, bank customers could withdraw funds from another bank’s ATM and pay a withdraw fee for cash withdrawals.
Online banking services typically include a more limited array of debt and loan services such as student loans, mortgages, business loans, etc. Online banking customers might also miss in-person services such as financial consultation, customer service, or receiving a cashier’s check. Without a physical location, safety deposit boxes also won’t be an option.
Though unlikely, an online bank’s website could have technical difficulties. If the site is temporarily unavailable, you wouldn’t have any access to your funds. Similarly, you need to have internet access to use an online-only bank.
Online banking is a great option for many people. Fortunately, you don’t have to use just one bank. You could use a traditional bank for your checking account and keep the rest of your money in a high-yield savings account online. A traditional bank or credit union will probably offer more conveniences for withdrawals, deposits, loans, or similar banking services, but will rarely have as good of interest rates as an online-only bank.
You don’t need to worry about the safety of your money in a reputable online bank. Like most traditional banks, good online banks are insured by the Federal Deposit Insurance Corporation (FDIC) and take steps to secure their website.
The FDIC acts as a safeguard against bank failure. Established in 1933 during the Great Depression, the FDIC protects against run-on-the-bank situations. If an FDIC insured bank fails, the FDIC will cover up to $250,000 per bank account holder, generally per account. If the bank you use is not FDIC insured, you have no guarantee of your money’s safety during a bank failure.
You can check if a bank’s website is secure by looking for the “https” instead of “http” before their URL. The “s” after http signifies that the website pays to have their site encrypted, a step they’ve taken to keep your money and transactions safe. This doesn’t make a website hacker-proof, but online banks are not at more risk to hackers than traditional banks as both use digital records.
A bank won’t make any money until it has customers with money in their accounts. They can then make money through loans, investments, fees, or shares.
Banks make money when they loan money to someone at a higher interest rate than they pay out to a customer keeping their money in the bank. For example, a bank could charge a 4 percent interest rate on a mortgage, but then only give .10 percent of interest to other customers whose money is funding the mortgage.
In addition to using your money to lend to other customers, banks will also sometimes use your money to invest in other assets. There are regulations to protect your money that limit how risky these investments can be.
Fees charged to customers like those for checking accounts, ATMs, overdrawing your account, or account closure also contribute to a bank’s profit.
Like any other business, a bank can also make money by selling shares of its ownership.
To keep your online banking even more secure, avoid shared Wi-Fi networks or public computers while accessing your account.
Online banks are very similar to normal or traditional banks, except they only operate online. This means they might have more limited features or account options, but will probably have some cool benefits like higher interest rates.
Online-only banks have higher interest rates because they have lower overhead costs. Because they spend less money on things like buildings, managers, or lollipops on the front counter, they can offer higher APYs (interest rates) and incentives to their customers.
A minimum daily balance, or minimum balance is the amount of money a financial institution will require you to have in your account to avoid monthly maintenance fees. Checking accounts almost always have a minimum balance requirement to avoid fees and savings accounts, including online savings account options, often have a minimum deposit required to open an account.
For example, if your minimum daily balance is $500, that means that if you have less than $500 in your account you could get charged a monthly service fee.
Though online banks tend to charge less fees in general, online checking accounts can still have minimum daily balances with fees attached. To combat this cost, you could look into an interest-bearing checking account with an internet bank.
See online bank reviews and our ranking of the best banks on the internet here.
September 27th, 2022
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