Choosing your first bank account can feel overwhelming. There are loads of new bank account offers to pick from, each offering different benefits — high interest, cash bonuses, mobile banking apps, and so on.
How can you tell which one is right for you?
The first step is to decide which kind of banking account you want. There are four common types of bank accounts — checking accounts, savings accounts, money market accounts, and CDs — and they all have their own advantages and disadvantages.
Here’s a quick rundown of the different types and what each one has to offer.
1. Checking Accounts
Checking accounts — known in other parts of the world as debit accounts or current accounts — allow you to deposit and withdraw money at any time, as often as you want.
At one time, the biggest benefit of these accounts was that they allowed you to pay for goods and services with checks — paper slips that were presented to your bank, which handed over the funds from your account. Nowadays, paper checks are increasingly rare, but the name has stuck around.
Benefits of Checking Accounts
Checking accounts offer the following benefits:
1. Maximum Access
Checking accounts give you more access to your money than any other type of bank account. These days, they come with both old-fashioned paper checks and a debit card, which you can use both for purchases just like a credit card and to make deposits and withdrawals at ATMs.
Most checking accounts also include free online banking and online bill payments.
2. Unlimited Transactions
Unlike other types of bank accounts, checking accounts allow you to make as many transactions per month as you want. Your deposits, withdrawals, debit card purchases, online bill payments, and other transfers are all unlimited.
This makes them a good choice for an account you plan to use to pay your everyday bills.
3. Low Cost to Open
You don’t need a large amount of money to open a checking account. Nearly every bank will give you an account with a $100 initial deposit, and some banks don’t require any deposit at all.
However, once you have the account, some banks require you to keep a certain amount of money in it to avoid fees.
4. FDIC Insurance
Like all other bank accounts, checking accounts are backed by the Federal Deposit Insurance Corporation (FDIC). That means if your bank goes out of business, you’re guaranteed to get your money back, up to a limit of $250,000.
Drawbacks of Checking Accounts
The biggest drawbacks of checking accounts are:
1. Little or No Interest
According to ValuePenguin, in 2020 the average interest-bearing checking account at a brick-and-mortar bank paid only 0.04% APY (annual percentage yield).
Online-only banks like Varo offered higher rates, but still no more than 1% APY on average. At those rates, your money won’t even earn enough to keep up with inflation — which means that even with the interest added, its buying power will slowly decrease.
And that’s only for accounts that actually pay interest; many banks’ checking accounts don’t pay any at all.
2. Maintenance Fees
As if the low interest rates weren’t bad enough, many banks charge a monthly fee, known as a maintenance fee or service fee, just to keep your checking account open.
A 2020 analysis by MyBankTracker found that the average checking service fee for U.S. banks is $9.60. This could easily be enough to wipe out all the interest you earn on your money and then some.
You can often avoid this fee by keeping a high enough balance in the account, but this minimum balance requirement can be as high as $1,500 at some banks.
Other banks waive the monthly maintenance fee if you set up a direct deposit — having your paycheck automatically deposited into the account.
3. Other Fees
Banks often charge a variety of other banking fees for checking accounts in addition to the maintenance fee.
They can charge you a hefty fee if you overdraw your account by accident and a small one for using another bank’s ATM. They can also tack on fees for replacing a lost debit card or for mailing you a paper statement each month, rather than delivering it online.
Types of Checking Accounts
It’s possible to get around some of the problems with checking accounts by choosing the right type of account. Banks offer many different flavors of checking accounts with different benefits.
Some common types include:
Free Checking
Free checking accounts do not charge a monthly maintenance fee. However, these accounts can still have other fees, such as overdraft fees. Also, they typically don’t pay interest.
High-Yield Checking
High-yield checking accounts, also known as rewards checking, offer higher interest rates than a typical checking account.
According to Bankrate, some high-yield checking accounts pay interest rates of 4% APY or more. However, you can typically only earn this high interest rate on a limited amount of money — anywhere from $3,000 to $30,000.
Also, you usually have to jump through a lot of hoops to get this rate, such as receiving direct deposits and making 10 to 15 payments each month with your debit card. If you don’t meet these requirements, your interest rate for the month drops to nearly nothing.
Student and Senior Checking Accounts
Some banks offer special deals for students and senior citizens. These accounts are free, have few fees, and pay a small amount of interest.
Alternatives to Traditional Checking Accounts
Another way to get a better deal on a checking account is to go to a credit union rather than a bank. Credit unions are nonprofit, so they can usually offer better interest rates and lower fees. However, they have fewer locations and a smaller network of ATMs.
Online banks, which have lower overhead than brick-and-mortar banks, can also offer better interest rates if you don’t mind doing all your banking over the Internet.
2. Savings Accounts
A traditional savings account, or deposit account, is the simplest type of bank account. You can deposit and withdraw money at any time and earn interest on your balance.
Because they’re so easy to use, they’re often the first type of account many people ever have. Parents often open savings accounts for their children to teach them how to save money, and teenagers can open them to stash earnings from a first job.
Benefits of Savings Accounts
The advantages of savings accounts include:
1. Interest Payments
Unlike checking accounts, savings accounts always pay interest, but they don’t usually pay much. According to ValuePenguin, some financial institutions offer rates as high as 1.3% APY, although this isn’t typical.
2. Low Opening Balance
You don’t need much money to open a savings account. Most banks require a minimum opening deposit of $100 or less, and some banks don’t require one at all.
3. Easy Access
Although savings accounts don’t give you as much access to your money as checking accounts, it’s still quite easy to make deposits and withdrawals. You can go into any bank branch to deposit a check or make a withdrawal, and you can access your cash at ATMs.
Most savings accounts also offer online and mobile access to check your balance and see recent transactions. And, like other bank accounts, they’re fully FDIC-insured.
Drawbacks of Savings Accounts
The major drawbacks of savings accounts are:
1. Limited Transactions
The main drawback of savings accounts compared to checking accounts is that they limit the number of transactions you can make each month.
You can make as many deposits as you like since banks love those, but most banks only allow six withdrawals or transfers to other accounts. If you go over this limit, the bank hits you with a fee that’s typically between $5 and $15.
At most banks, this cap doesn’t apply to ATM and teller withdrawals, but some banks put limits on those as well.
2. Low Interest
Although savings accounts pay interest, they don’t pay that much. According to ValuePenguin, many large banks pay only 0.01% APY on savings accounts — literally pennies per month.
Other types of accounts, such as CDs and money market accounts, usually offer better returns.
3. Debit Card Not Included
Unlike checking accounts, most savings accounts don’t come with a debit card you can use for purchases. That’s probably a good thing because you can only make a limited number of transactions anyway, but it does make it a little harder to use your money.
Higher-Paying Savings Accounts
Some banks offer high-yield savings accounts, which yield much higher interest than the average savings account. There are several high-yield savings accounts with interest rates of 0.6% APY or better. However, that’s still not as high as some rewards checking accounts.
Also, high-yield savings accounts sometimes require a high opening balance or minimum monthly balance.
Online banks can offer better rates for savings accounts, just as they do for checking accounts. These online accounts come with the same benefits as a typical savings account, but you can’t make teller withdrawals, and you could have fewer ATMs to choose from.
3. Money Market Accounts
A money market account (MMA), also known as a money market deposit account, combines some of the features of a savings account and a checking account. It allows you some check-writing privileges, but only a limited number of transactions each month.
Benefits of Money Market Accounts
Money market accounts have the following benefits:
1. Slightly Higher Interest
Money market accounts don’t pay a fixed interest rate. Instead, their yield fluctuates based on money market rates.
Most of the time, these accounts pay higher interest than savings and checking accounts, but their rates aren’t guaranteed.
2. FDIC Protection
A money market account isn’t the same thing as a money market fund, which is a type of mutual fund that invests in the money markets. MMAs are fully backed by the FDIC, so you can’t lose your money.
3. Check and Debit Access
Unlike most savings accounts, money market accounts come with paper checks, a debit card, or both. However, as with a savings account, you can only make six check or debit payments per month.
Drawbacks of Money Market Accounts
The drawbacks of money market accounts are:
1. High Minimum Balance
Most money market accounts require a lot more money to maintain than a standard savings or checking account. According to U.S. News, most MMAs require a minimum balance between $100 and $10,000.
However, there are a few banks that have no minimum balance requirement.
2. Limited Transactions
Most money market accounts limit the number of transactions you can make by check, debit card, or online transfer to six per month. If you have an online-only account, that limit covers withdrawals as well.
3. Modest Interest
Most money market accounts offer an APY of 0.55% or less. That’s better than the average rate for a savings or checking account, but it’s still not high enough to beat inflation.
There are some MMAs that pay rates of 1% APY or better, but to earn that rate you must generally keep a sizable balance in the account — usually at least $5,000.
4. Certificates of Deposit (CDs)
Certificates of deposit, or CDs, are different from other bank accounts. When you take out a CD, you’re basically loaning money to the bank for a fixed period of time.
In exchange, the bank agrees to pay you a fixed amount of interest when that term is up. The longer the term of the CD, the more interest it pays.
Benefits of CDs
The chief advantage of CDs is that they pay higher interest than other bank accounts.
In July of 2020, ValuePenguin reported that the average interest rate for a one-year CD — one that pays off at the end of a year — was 0.59%. Five-year CDs were paying an average of 1.23% per year.
“Jumbo” CDs, which require an initial investment of at least $100,000, pay even more.
Drawbacks of CDs
CDs have two major drawbacks.
First of all, most banks require a fairly large chunk of money to open one. According to GOBankingRates, the minimum amount to open a CD at most large banks varies from $500 to $2,500, although there are a few banks that don’t have a minimum amount.
The other problem is that CDs tie up your money for a fixed amount of time. Other types of accounts let you put money in and draw it out as needed, but when you buy a CD, you can’t get that money back until the CD matures.
Typical terms for a CD include six, 12, 18, and 60 months. If you cash in the CD before that period is up, you’ll have to pay a steep early withdrawal penalty that could eat up all the interest your CD has earned and then some.
Buying CDs can be a big problem when interest rates are exceptionally low, as they are now. As this chart from Bankrate shows, interest rates for five-year CDs have plunged from a peak of just below 12% in 1985 to around 1% today.
That means if you buy a five-year CD today and then, within a year or two, interest rates for this type of CD shoot up to a more typical 4% or 5%, you won’t be able to take advantage of the higher rates. You’ll be stuck earning 1% APY until your CD matures.
Types of CDs
There are several ways to maximize the benefits of CDs while minimizing their downsides. These include:
CD Ladders
One way to scale back the risks of long-term CDs is to build a CD ladder. You split the money you want to invest into several equal sums and put them into multiple CDs that mature at different times.
For instance, if you have $2,000 to invest, you could put $500 each in a six-month, one-year, two-year, and five-year CD. That way, you always have one CD earning the best interest rate that’s available right now, but you also have one that will mature quickly.
Then you can use the money if you need it or reinvest it in a higher-paying CD if interest rates have risen.
Liquid CDs
Liquid CDs, also known as no-penalty CDs, allow you to withdraw some or all of your money at any time without paying a penalty. However, there are usually some restrictions as to when you can withdraw your money or how much you can take out at once.
Also, liquid CDs pay lower interest rates than standard CDs. A 2020 report from Bankrate found that many short-term liquid CDs (between even and 14 months) paid between 0.1% and 0.6% APY — less than a high-interest checking account, which is fully liquid.
Bump-Up CDs
A bump-up CD, or rising-rate CD, is another way to avoid tying up your money at a low interest rate. With these accounts, if interest rates rise, you have the option to “bump up” your earnings to the new, higher standard rate.
For instance, if you open a five-year CD today at 1% APY, and by next year the standard interest rate has doubled, you can exercise your bump-up option and increase your earnings to 2% APY for the last four years.
The catch is that, like liquid CDs, bump-up CDs start out at a lower rate than standard ones. Also, in most cases, you can only bump up your rate once during the term of the CD.
If you bump up your rate to 2% after one year and interest rates then continue to rise, you’ll be stuck earning 2% for the next four years. And, of course, if interest rates fall or stay flat, your bump-up option will have no value at all.
Which Type of Bank Account Do You Need?
Clearly, there’s no one type of bank account that’s “best.” Instead, it’s a question of which is best for you — which one offers the advantages you need most, combined with drawbacks you can live with.
Here are a few questions to help you decide what kind of bank account is best for your needs:
How Much Money Do You Have?
If you have only a small amount of money to put into a bank account, savings and checking accounts are your best bets. You can open these accounts with a deposit of $100 or even less.
If you have a larger sum to stash away — say, $2,500 or more — you might earn better interest by choosing a money market account or a CD.
How Will You Use the Account?
If you plan to use the account to pay your day-to-day bills, a checking account is the best choice. You can make as many transactions as you want, and you can use checks and debit cards for purchases.
For an emergency fund, which will spend most of its time sitting and gathering interest except when you dip into it to cover an unexpected expense, a savings or money market account is a good choice.
And if you want to squirrel away a sum of money you won’t need for several months, or even several years, and let it grow as much as possible, then a CD could be a good choice.
Can You Avoid Fees?
Pretty much every bank account comes with some kind of fees attached. However, in most cases, there are ways to avoid them.
For instance, you can usually avoid maintenance fees by keeping a minimum balance in your account or by using direct deposit. Likewise, you can avoid excess activity fees by limiting the number of withdrawals and transfers you make each month.
Figure out what kind of rules you can work with, and then choose an account that fits within those limits.
Should You Open Multiple Accounts?
Keep in mind that you’re not limited to opening just one account. For instance, you can open a checking account to use for your everyday transactions, plus a savings or money market account where you keep the bulk of your savings.
Many banks make it easy to open multiple accounts and link them so that you can easily transfer money back and forth.
Final Word
Although this is a good summary of the different types of bank accounts, it’s far from a complete list of all the places it’s possible to stash your money.
For instance, you can put money into a brokerage account or a retirement account, such as an individual retirement account (IRA) or a Roth IRA. Sometimes these accounts are even available at the same bank where you have your checking or savings account.
Money inside these other types of accounts can also be invested in securities, such as stocks and bonds, which offer much higher potential returns than a CD earning 1% or 2% APY.
However, because these other accounts aren’t bank accounts, they aren’t guaranteed by the FDIC. So, while you could earn more money on these accounts, you also could lose some or all of your principal.
If you want to grow your savings and eventually reach financial independence, you can’t just keep it in a bank account indefinitely. Sooner or later, you’ll need the higher returns these other types of accounts can provide.
But if you just need a place to park your savings safely and keep them accessible when you need them, a bank account is the best place to do it.
