If you're building an emergency fund, saving for a big purchase, or getting money together to invest, using an insured savings account can put you on the right road.
Most banks offer a variety of savings accounts. So do credit unions. In addition to these basic savings accounts, other popular bank savings options are money market accounts, which combine savings with limited check-writing privileges, and certificates of deposit (CDs).
With a savings account, you make money on the money in your account by earning interest, or a percentage of your balance, at a specific rate on a regular schedule. What you earn depends on the interest rate the bank pays—typically about the same rate that other banks are paying on similar accounts. That rate, in turn, depends on the rate that banks are earning on the loans they make and on what it costs the banks to borrow from each other.
The most basic accounts, where you can deposit and withdraw money at any time, are called regular savings, or sometimes statement savings accounts. What that means is that any activity in the account—deposits, withdrawals, fees, or interest earnings—and your current balance are reported in a printed or online account statement, usually once a month.
You earn interest on a regular savings account only if you keep at least the required minimum on deposit. If your balance is lower, some banks don't pay interest and others may charge a fee for holding your money. Unless you qualify for exemption from the fee—by being a full-time student or older than 65—you're stuck. The alternative is to look for an account without a required minimum or wait until you have the $500 or whatever is required.
In reality, though, you don't put money in a regular account for the earnings. Whatever the interest rate is, it's likely to be the lowest one the bank offers. You just want to avoid having to pay to keep your money on deposit.
Most banks offer hybrid accounts—part checking, part saving—called money market accounts (MMAs) or sometimes money market deposit accounts. They're similar to money market mutual funds, but have the advantage of FDIC insurance.
MMAs typically pay higher interest rates than regular savings accounts, and may offer blended or tiered rates, which means you can earn an even higher rate on large balances or on part of your balance over a certain level.
And you can usually make a limited number of cash transfers or write a limited number of checks—generally a total of three—against your account each month.
The catch is that there are substantial service fees if your account falls below the bank's minimum required balance. You may also forfeit your interest if the balance drops below the minimum, or you may face both penalties.
Certificates of deposit (CDs)—called share certificates at a credit union—are high-end savings accounts. They generally pay interest at a higher rate than other bank or credit union accounts, so it should come as no surprise that there are some strings attached.
What makes CDs different from regular savings accounts is that they're time deposits. That means that when you open a CD you agree to commit your money for a specific term, or period of time. You also agree that if you withdraw money from the CD before it matures when the term ends, you'll forfeit some or all of the interest you would have earned.
Typical terms include six months, a year, two and a half years, and five years. But the term may be any period you and the bank agree on. The longer the term, the slightly higher the interest you may earn. There may be a minimum deposit—often $500—and some banks may pay slightly higher rates for large deposits.
When a CD matures, you can roll over the money into another CD, transfer your money to a different account, or have the bank send you a check. But you must tell the bank what you want it to do by the deadline it sets, or the decision will be made for you. When the bank decides, your CD is usually renewed for the same term as the expiring one at the bank's current rate for a CD of that length and principal.
When banks advertise the interest rates on their savings accounts, they tell you the nominal rate and the annual percentage yield (APY). The nominal, or named rate, is the rate they pay. The APY is what you earn over the course of a year, expressed as a percentage of your principal.
What you actually earn depends on whether the account pays simple or compound interest. Simple interest is calculated annually on the amount you deposit. With compound interest, which can be paid daily, monthly, or quarterly, the interest is added to your principal to form a new base on which you earn the next round of interest.
How can you tell whether interest is simple or compound? If the nominal rate and the APY are the same, you're earning simple interest. If the APY is higher, the interest is compound.
If you have bills that come due at specific times, such as tuition payments that you must make in August and again in January, your bank may agree to let you open one or more CDs with a special term that will mature when you need your money, even if it's not the conventional six- or twelve-month period. They may even offer a slightly better rate than a shorter CD. That way, you'll not only have the money when you need it, but it will be easier to resist the temptation to spend it on something else.