Savings accounts pay almost no interest now because the economy is in trouble. The Federal Reserve, the federal banking authority of the United States, which provides banks with a central source of reserve cash, has the power to influence the economy by either increasing or decreasing interest rates.
How do interest rates affect savings accounts?
When you have committed your time to working hard and saving your money (rather than borrowing recklessly and spending wildly) it can be dispiriting to find that money invested in savings accounts pay almost no interest.
When the economy is expanding extremely quickly, the Federal Reserve often raises interest rates in order to reduce borrowing and limit spending, thus preventing excessive inflation. However, when the economy is weak, as it is as the moment, the Federal Reserve lowers interest rates. The idea is to encourage people to borrow money in order to increase spending and thus stimulate the economy.
When you have a savings account, the bank or credit union uses your money to fund the loans that they provide to other people. They charge interest on these loans and pay you interest on your money. Banks and credit unions make a profit by charging more interest than what they pay out.
At present, interest rates are extremely low and have been this way for some time. The Federal Reserve has decreased the interest rate to promote spending and borrowing, but this has not worked very effectively. Many people are completely overwhelmed by financial turmoil and are spending their spare money paying off debts, rather than taking on new ones. Furthermore, because the banks suffered so deeply during the global financial crisis, they are not as willing to offer loans as they once were. They are concerned that these loans will default, plunging them into financial instability, if not total failure.
How much interest do savings accounts actually earn?
Because the banks are not earning very much from their loans, they are not paying very much interest on savings accounts. As of November 21, 2011, the Federal Deposit Insurance Corporation states that the average national rate for non-jumbo deposits, which means less than $100,000, is 0.11% on savings accounts, 0.07% on interest checking accounts, 0.16% on money market accounts and 0.34% on twelve-month CD accounts.
For jumbo deposits, which means more than $100,000, the average national rate is 0.11% on savings accounts, 0.07% on interest checking accounts, 0.25% on money market accounts and 0.37% on twelve-month CD accounts. These figures are based on data from banks and branches in at least 49,000 locations.
Note that these are averages only. If you are considering savings account options, you would be wise to do some research, as it is possible to find money market accounts offering rates as high as 1.5%. Some online savings accounts have better rates than those offered at bank branches.
Is a Certificate of Deposit a better choice?
Moreover, as you can see from the statistics, Certificate of Deposit, or CD, accounts provide the best rates, as far as savings accounts go. One of the difficulties of CD accounts is that your money is not easily accessible. When you open a CD account, you agree to leave the money in there until it matures, and if you need to withdraw it beforehand, you face a penalty.
However, the benefit of CD accounts is that the interest rate with which the account starts generally remains the same. Therefore, you do not suffer from sudden drops in interest rates in the way that you do with standard savings accounts or money market accounts.
What are other reasons why interest rates are low?
In a 2010 article, Ron Lieber of the New York Times makes a few other important points regarding the reasons why savings accounts pay almost no interest. He points out that banks which maintain high rates “run the risk of attracting hot money.” “Hot money” refers to large amounts of money that are deposited in savings accounts but withdrawn quickly when a competing bank or credit union offers a higher interest rate. This can obviously fuel the financial instability of a financial institution.
Lieber also argues that sometimes banks can maintain low interest rates on savings accounts because of “lazy customers.” Many people keep just one savings account with their financial institution, rather than opening a linked account that offers a better interest rate. Banks, like most companies, respond to consumer demand. If you keep most of your money in an account that offers a higher interest rate, you are not only benefitting financially, but also sending your bank or credit union the message that you know how to maximize your investment with them.
One of the overall benefits of decreasing the interest rate is that it has prevented the tumbling economy from receding into an even deeper recession. This might be useful to remember, despite times being hard, for both borrowers and savers. If you are considering opening a new savings account or changing your current one, you would be wise to research your options thoroughly to find the best possible rate.
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