When I first came across a high-yield savings account (HYSA), I thought it was a scam. I’m a firm believer in the saying, if it sounds too good to be true, it probably is. So when I found a savings account that said it would pay me 25x the rate I was currently getting just for putting my money in it, I figured there must be a catch. After doing a full-blown investigation to determine if high-yield savings accounts are, indeed, too good to be true, this is what I learned.
What Is a High Yield Savings Account?
A high-yield savings account or high-interest savings account is a type of savings account that pays you a higher interest rate for keeping your money in it. Traditional savings accounts, like the one you open alongside your checking account, pay around .01% interest on the money you keep in them. HYSAs pay far more than that but have fluctuating interest rates.
When the Federal Reserve Committee (the Fed) lowers interest rates, the interest rate HYSAs pay you also decreases. When the Fed raises rates, HYSA rates rise as well. In the last several years, HYSA rates have fluctuated between .4%-2.5% while traditional savings account rates have remained at .01%. Even though the Fed reduced rates to help stimulate the economy during the Covid recession, HYSA rates are still significantly higher than traditional savings rates and when the Fed begins to increase rates in the next few years, HYSA rates will increase also.
But all this information on rates begs the question, how can HYSAs pay you more than traditional accounts for doing the same thing?
How Does a High Yield Savings Account Work?
All savings accounts work the same way. A bank pays you a fraction of the interest they earn from lending out the money you deposit with them. That’s right, banks don’t actually keep your money safe in a special mini vault until you want to use it later. Instead, they lend it out to other people in the form of mortgages, auto loans, personal loans, etc., and charge interest to their borrowers on those loans. Your bank then pays you a fraction of their interest earnings to incentivize you to use their bank.
The difference between traditional savings and HYSAs is that traditional savings accounts pay you a smaller fraction of the interest they earn than HYSAs, mostly because traditional banks have more expenses. Many of the banks offering HYSAs are online-only banks with no brick and mortar locations, and they don’t offer debit cards or access to withdraw your money from ATMs. Because of this, they’re able to save tons of money on rent, frontline worker salaries, and ATM machines. This gives them more wiggle room to pay a higher interest rate to their depositors, AKA you.
How to Choose a High Yield Savings Account
Make Sure It’s FDIC Insured
The first step you should take to make sure the HYSA you’re interested in is legit is to verify that the bank it’s with is FDIC insured. The Federal Deposit Insurance Corporation (FDIC) is an independent agency of the US government that protects depositors’ money in the event of theft or bankruptcy.
What that means is that if your funds are hacked/stolen or your bank runs out of money and shuts down, the federal government will compensate you in full for up to $250,000 in your savings account. It’s essentially free insurance to protect your money if your bank fails. Since the bank isn’t keeping your money in a mini vault and is instead lending it out, and the prevalence of hacking is on the rise, it is critically important that you save your money in a HYSA with a bank that is FDIC insured.
Check Balance Minimums & Fees
One of the best uses for a HYSA is to hold your emergency savings, but what happens if something comes up and you need to pull all of your money out? You don’t want to get hit with fees for dropping below your minimum balance requirement when you’re already dealing with a financial emergency.
When evaluating your HYSA options, choose an account with a $0 minimum balance requirement. Also, check on the fees you may be charged for other types of transactions. On top of their interest earnings, banks make a killing from charging additional fees. There may be a limit on the number of withdrawals you can make each month or limits on other transactions. Depending on how often you need to move money in and out of your account, you could be charged a fee if you exceed your designated number of transactions. All of these fees add up and unnecessarily eat into your savings. It’s best to select an account with as few fees as possible.
Focus on Functionality, Not the Best HYSA Rate
As you learned earlier, HYSA interest rates fluctuate, so different banks have different rates at different times. One bank may offer you a slightly higher interest rate today, and another bank may do the same next quarter. Since these rates usually only differ by a tiny fraction of a percentage, the minuscule increase in earnings you’d receive by switching to the savings account with the highest rate every quarter isn’t worth the hassle.
Instead of focusing on getting the highest rate, shift your focus to finding an account that offers the functionality that is best for you. Some accounts offer debit cards, while others don’t. Some offer incredible organizational features so you can easily save for multiple goals and track your progress. Some have no frills and just offer one simple account to hold all of your money. Whatever account fits your personality and goals best is the one you should choose, not the one with a .05% higher interest rate.
So while HYSAs seem too good to be true, they actually… aren’t! They simply do offer significantly higher interest rates than traditional accounts with no hidden catch. They’re the best place for you to keep your emergency fund and to save for other long-term goals like a down payment on a home or a new car. Just make sure you choose an account that’s FDIC insured, has a $0 minimum balance and low to no additional fees, and has all the bells and whistles you need to help you reach your goals. Once you find the best account for you, you should 100% put your money into a high-yield savings account.
To find out how much you should have saved for an emergency, get my FREE Emergency Savings Calculator!