51M. As a child I had a children’s saving account with compound interest. My $100 went up to just below $200 in around 4 – 5 years. That seems like peanuts, but to a kid that was a lot.As a young adult, in the mid 1990s, I remember my older colleagues were talking seriously about CD interest rates to put away for up to five years, at 6%.
Now, in 2024, with the major banks, a one-year CD from Bank of America is 0.03%. Maximum rates for 5 years is 2.5% at Chase, no matter how much money you put away. Savings accounts compound interest rates are 0.01%, max, IF you maintain at least $10,000 in the account.Yet interest rates for a housing loan are at 7% and putting housing purchases out of reach. How can the banks do this?
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In: Economics
A savings account is basically you extending a loan to the bank, they loan your money out to others at a higher interest rate, and they pocket the difference. The downside from the bank’s viewpoint is you can demand your money back at any time.
CDs are basically the same idea as a savings account, except you can’t just demand all your money at any time without penalty — that makes it easier for the banks to do bank things, making sure they have enough cash lying around. So they usually pay a slightly higher rate on CDs than they would on a savings account.
The bank doesn’t HAVE to borrow from you — they could borrow from the fed if they want. And the fed isn’t going to suddenly demand all their money. So they’re really only interested in borrowing from you if it’s cheaper than borrowing from the fed.
https://fred.stlouisfed.org/series/FEDFUNDS
There’s the effective federal funds rate over time. Back in the late 80s, the federal funds rate was near 10%, so they could offer fairly high rates to customers. When the 2008 crash happened, the federal funds rate dropped to nearly 0%, so there was no benefit in borrowing from people vs borrowing from the fed. So they offered some absurdly low savings account rates. That rate has generally stayed low until 2022, so there was a long stretch where higher savings rates weren’t around. Now the federal funds rate is back up to over 5%, so you can find savings accounts and CDs that pay something in the vicinity of 5% again.
Why do some banks like BofA offer savings accounts and CDs at way lower rates than you can find elsewhere? I don’t know, but I can speculate…
* Greed. The larger the difference between the rate they offer you and the rate they loan the money out at, the more money they pocket.
* They don’t want to loan money out, so they don’t want your money. Some banks prefer to make their money servicing loans rather than actually holding the loans because it’s lower risk. If they don’t hold the debt, then they aren’t harmed if somebody stops making payments.
* Connections to other accounts. Chase offers like 0.01% on CDs, even lower than Bank of America, but they offer higher rates if you have a linked checking account. They’re after customers, not just cash on hand.
* Convenience — they’re selling access to an ATM network, brick-and-mortar locations near you, etc. So maybe they can get away with offering crappy rates.
EDIT:
You can go around hunting for high rates on savings and CDs… there’s nothing wrong with doing so. But be aware that you may have other options with less hassle. Money funds are a type of mutual fund that invests in things like short term CDs, short term government bonds, etc. They generally have a fixed price per share of $1.00, and they pay out any gains as dividends. Most brokerages have money funds that you can trade with zero fees. (e.g. VMFXX at Vanguard, SWVXX at Schwab, SPAXX at Fidelity). Their dividend yield is generally competitive with savings and CD rates, though you might find teaser rates even higher at some random bank. Currently, VMFXX at 5.27%, SWVXX at 5.2%, SPAXX at 4.98%. A downside is the rates aren’t “locked in” like the rate you might have with other vehicles. If the fed drops the funds rate to near 0% tomorrow, these would start returning near 0% as well. On the other hand, the opposite is also true… If rates go up tomorrow, these start returning higher rates too.
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